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Summary of My Post-CPI Tweets (December 2022)

January 12, 2023 1 comment

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but to get these tweets in real time on CPI morning you need to subscribe to @InflGuyPlus by going to the shop at https://inflationguy.blog/shop/ , where you can also subscribe to the Enduring Investments Quarterly Inflation Outlook. Sign up for email updates to my occasional articles here. Individual and institutional investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Check out the Inflation Guy podcast!

  • It’s #CPI Day – and this one finishes up the book for 2022.
  • I am doing the walk-up differently today. I’m doing it as a thread on the night before, which I’ll re-tweet in the morning. I’m usually doing the analysis in the evening…why wait?
  • Today’s number, or I guess really we can say starting with October or November, starts the interesting part of the inflation cycle.
  • When inflation was going up, excuses abounded but the real debate was WHEN the peak was going to be, and HOW HIGH only to a lesser extent. Now that inflation appears to be clearly decelerating, the much more important debate is: where is it decelerating to?
  • If inflation drops back to 2%, and becomes inert at that level again, then the Fed will deserve considerable laurels. If inflation instead drops to 4% and appears resistant to a drop below that, then a much more interesting debate will ensue.
  • I think it should be clear that I am in the latter camp.
  • The other interesting thing that we’re going to see, and are already seeing, is manifestation of the basic tricks of the trade of macro economists.
  • Trick 1 is to assume that everything returns to the mean. Most things do, eventually, return to the mean – so if you are wrong on the timing, you’ll probably eventually be right. Economists love to forecast returns to the mean.
  • Economists though are very bad at forecasting departures AWAY from the mean, which is why there were so many forecasts of “transitory” this cycle.
  • Since they didn’t see it coming, it must have been a random perturbation (because that’s how their models work). But it’ll all go back to the mean and all is right with the world. Or so goes the assumption.
  • Trick 2 is to assume that the mean doesn’t change, or changes pretty slowly. In econometrics terms, the distribution is ‘stationary.’ If you’re going to forecasts returns to the mean, it is fairly important that the ‘mean’ is known or knowable and doesn’t move a lot.
  • The problem in inflation is that the (unobservable) mean of the distribution never appeared to be very stable until the mid-1990s; the hypothesis is that this anchoring happened because of “anchored inflation expectations.”
  • (A member of the Fed’s own research staff tore apart that notion in a devastating article a couple of years ago, but the Fed promptly ignored him because if he was right it’s really bad for forecasting the way that they like to forecast: everything returns to the mean.)
  • Getting to Thursday’s CPI figure, we can see these tricks in play in the economist forecasts.
  • As an example, one of the forecasts I saw from a large bank had drags calculated from Used Cars (and New Cars), a deceleration in shelter costs, a drag from airfares due to lower jet fuel costs, and a drag from health insurance. But what about accelerations?
  • Do you really think that NOTHING will accelerate, or are all of those pre-defined as “one-offs”?
  • It reminds me a little of what Rob Arnott says about the S&P earnings “ex-items”: any one company it might make sense to ex- the unusual events. But in aggregate, some level of unusual events is usual. So it is with inflation.
  • There will be some ups. So my forecasts are a little higher than others’, because I anticipate there will be some surprises.
  • Where would those surprises come from? Wage growth is strong, and that pushes up on prices in hospitality, domestic manufacturing, food away from home, and even shelter.
  • I also don’t think that airfares will be the drag that’s implied by jet fuel. Here’s the regression that would make you think they WOULD.

  • But here’s the one that makes you think maybe not. Airlines tend to push prices higher when there are spikes in jet fuel costs, but they don’t necessarily lower them very fast when jet fuel prices decline. And did I mention wage pressures? Airlines feel them.
  • I do think that used car prices will drag again, although the CPI has been falling a little faster than the Black Book and Mannheim indices would suggest they should. But I don’t see a strong argument for New Car prices to decline.
  • New Cars are in black in this chart, while Used are in blue. New car prices are up 20%, while used are up 40%, since the end of 2019. And the money supply is up around 40%. That doesn’t mean new car prices won’t decline, but it doesn’t look like a slam dunk to me.
  • Finally, a point I’ve been making recently on a longer-term horizon viewpoint. Markets are fully priced for inflation to totally and almost immediately mean-revert. Large declines in breakevens, especially short BEI. Some of that is the gasoline slide. Not all of it.
  • The short end of the inflation swap curve has NSA inflation at -0.38% m/m in December, +0.37% in Jan, +0.33% in Feb, and 0.30% in March. And that’s the last 0.3% print we see. According to inflation swaps, y/y inflation will be at 2% in June.
  • Even if I am wrong about inflation staying around 4-5%, you have a 2% cushion to bet that way. (I think I used an unfortunate analogy a few days ago saying that if you give me 21 points I’ll take TCU over Georgia, but you get my point.)
  • Ergo, for choice I’d be long breakevens going into this number.
  • The response in the stock market will be interesting. If the number is as-expected or better, I would think stocks will try and scream higher on the theory that the Fed can back off. The problem is that folks are already long for that, I sense.
  • So I’d probably sell that pop, especially because earnings may be a hurdle in the near future, though you have to be cognizant of the 200-day moving average in the S&P. The mo-mo crowd will try to get some prints above that so I’d be cautious.
  • What about on a strong CPI? Few seem to be thinking/talking of that, which means to me that folks are a little naked there. Do I think it would change the Fed trajectory? Not from what the Fed is SAYING they’re doing, but from what the market is pricing – yes.
  • As I said, this is the interesting part of the inflation cycle. Buckle up.
  • At 8:30ET, I’ll be pulling the data in & will post charts and #s – then retweet some of those charts w/ comments plus other charts. Around 9:30ish, I will have a private conference call for subscribers where I’ll quickly summarize the numbers.
  • Pre-release, both stocks and bonds are loving this number! May be that some are reading into the fact Biden has a speech this morn including inflation as a topic, and perhaps he wouldn’t if the number was bad. But even if it is, he can focus on y/y so not sure that means much…
  • That’s all for now. Good luck!

  • m/m CPI: -0.0794% m/m Core CPI: 0.303%
  • Last 12 core CPI figures
  • Overall, highest core number in 3 months, but clearly in a down trend. I think lots of people would be DELIGHTED with 3.6% annualized compared with where we have been, but that’s closer to what I am expecting than what the market/Fed is looking for.
  • M/M, Y/Y, and prior Y/Y for 8 major subgroups
  • Interesting thing is apparel, up for the second month in a row. Apparel is an almost pure import, so if it’s up then either (a) the recent dollar weakness is already affecting prices or more likely (b) there is pricing power at retail, and the markdowns for Christmas were lower.
  • Core Goods: 2.15% y/y Core Services: 7.05% y/y
  • The story continues to be bifurcated and we will look further at the four-pieces. More important than the fact that services are trending and goods are deflating, is whether the services part was all rents.
  • Here is my early and automated guess at Median CPI for this month: 0.378%
  • Clearly good news! Lowest median m/m in quite some time. So core was higher, but median lower. THIS is positive. And as I said, this is the interesting part now: inflation is decelerating, but why and how fast and how far? Median clearly shows it is.
  • Primary Rents: 8.35% y/y OER: 7.53% y/y
  • Further: Primary Rents 0.79% M/M, 8.35% Y/Y (7.91% last) OER 0.78% M/M, 7.53% Y/Y (7.13% last) Lodging Away From Home 1.5% M/M, 3.2% Y/Y (3.2% last)
  • Although the rent data is clearly bad news, there has been a strong campaign against this data to weaken its importance by claiming it’s just really lagged. That’s partly true but the recent research on the subject has enormous error bars for short-term forecasts so…
  • Some ‘COVID’ Categories: Airfares -3.12% M/M (-3.02% Last) *** Lodging Away from Home 1.47% M/M (-0.71% Last) *** Used Cars/Trucks -2.55% M/M (-2.95% Last) *** New Cars/Trucks -0.06% M/M (0.04% Last)
  • So, I was ‘on’ core even though I was wrong on airfares (it was weak, despite the fact that every fare I saw in December was about 2x normal). Used cars was the predicted drag, and New cars was not…but I was low on rents. That’s the ‘away from mean surprise’.
  • Incidentally, Lodging Away from Home was quite strong – and is one of those core-services-ex-rents that is driven a lot by wages.
  • Piece 1: Food & Energy: 9.31% y/y
  • Piece 2: Core Commodities: 2.15% y/y
  • Piece 3: Core Services less Rent of Shelter: 6.34% y/y
  • …and here is the spoiler: it wasn’t all rents. Core services less rents still strong. I’ll drill down further in a bit.
  • Piece 4: Rent of Shelter: 7.59% y/y
  • So, the swap market gets closest-to-the-pin on headline (SA). -0.079% was the figure, a bit lower than consensus econs and a fair bit lower than me. On Core, econs and I were both pretty close as it was right around 0.3% (0.303%).
  • I had managed to talk myself into the idea that food and energy would be a bit less of a drag than my model said, but food wasn’t up as much as it has recently been. Ergo, right on core and off on headline.
  • Interesting story in Medical Care, which has been a drag recently because of the huge adjustment to insurance company margins (huge and unlikely, btw). Doctors’ Services is slowly reaccelerating a little. Hospital Services continues to have problems getting sufficient sample.
  • Overall, Medical Care was up 0.1% m/m, but that’s after the continuing ‘insurance’ drag. Y/Y it was at 3.96%, down from 4.15% but looking like it’s leveling out.
  • The median category in the Median CPI will be Food Away from Home, +4.63% annualized monthly number. And the y/y Median will decline very slightly again. Was 7.00% in Oct, 6.98% in Nov, 6.93% in Dec. But heading down.
  • Biggest upward m/m movements in core categories were in Jewelry/Watches (+48% annualized monthly), Mens/Boys Apparel (+22%), Lodging Away from Home (+20%), Motor Vehicle Maint/Repair (+13%), and South Urban OER.
  • • Biggest decliners were energy things, including Public Transportation, plus Used Cars (-27% annualized monthly figure), and Car/Truck Rental (-18%).
  • Core ex-shelter: this includes core goods decelerating rapidly and core services accelerating so perhaps isn’t as useful as sometimes: 4.48% y/y, down from 5.2% last month and the lowest since April 2021. But if it stayed there, then it’s hard to get core to 2%.
  • While I’m waiting for the diffusion stuff to calculate, a word on what this does to the Fed: nothing. The Fed is aiming for 5% and then will keep rates high for a while unless something breaks.
  • Do markets love this data today because it means they were worried about a more-hawkish Fed, with higher rates or higher-for-longer? Or do they think it means the Fed will in fact start easing this year as the curves impound?
  • In my view, the latter is really unlikely. I can see the Fed starting QE again if auctions start getting difficult, but in my view there’s no evidence here that we’re going right back to 2% inflation and the Fed has been loudly consistent about this.
  • To be sure, they can turn on a dime and they have previously, but…I just think market pricing is really optimistic.
  • This [chart below] is consistent with the good news from Median – for the first time, our diffusion index has declined smartly. It’s still above the highs of the last couple of inflation ‘spikes’ (which no longer look like spikes!), but moderating.
  • This chart is not quite as good. The mean CPI is falling more because some high outliers (cars e.g.) are coming back to the pack, and some are moving from low to the low tail, and less because the middle is shifting a lot. Look at how >5% is barely declining.
  • I mean, that’s not TERRIBLE news, but obviously we need to see the “<2%” get close to 50% if the Fed is going to be confident they’re back near their inflation target. • One more point and then I’ll prep for the call. A lot of the positive-news things are well along towards delivering what they’re going to deliver. Health ins won’t be a drag in 2024. Used cars won’t drop another 20%. And >>
  • >>the dollar has turned south so core goods won’t be in retreat forever. The case for inflation going back to 2% rests on rents turning, and on wages slackening. And while those are expected, there are scant signs of them yet. So hold off on the celebrations in the Eccles bldg.
  • OK, let’s wrap up and get to the call. Thanks for subscribing. at 9:35ET I’ll be on this call; join if you want to hear me say what I just tweeted. 🙂 [NUMBER REDACTED]

The CPI figure was broadly in line with expectations, which means it was a “something for everybody” kind of number. Disinflationists see continued broad progress towards the Fed’s 2% PCE target, while sticky-inflation folks see the rents and core-services numbers and shake their heads, tsking ominously.

Two broad observations:

First, the disinflation from core goods is ‘on schedule,’ with Used Cars and other core goods categories doing approximately what they are expected to do. But the problem is that core goods inflation is down to 2.1%. If you are looking for the whole number to go back to what it was pre-COVID, you need core goods in mild deflation and core services down to 3%. But both parts of that story are difficult. With the world de-globalizing and near-shoring, it is going to be difficult to see core goods back in an extended period of mild deflation. Probably 0-1% is the best we can really hope for. And that means that the core goods sponge has been mostly wrung out. And core services back to 3%, even if rents are actually peaking (and just not showing up in CPI yet)? Well, core services-ex-rents remain pretty buoyant. So how do we get that back to 3%?

Second. The interesting part of the story is coming up. Inflation is probably returning to “the mean,” but what is the mean inflation now? For a quarter-century it was stable at 2-2.5%, but prior to that it had never been very stable. There are feedback loops in inflation, and those appear visibly to be at work here: higher wages help support higher services inflation, and rents, which in turn support higher wages. Social Security and other wage agreements that are explicitly linked to inflation help this process along. But it means this: the mean is not stationary. The real question of 2023, and probably 2024, is this: what is the mean, now?

My guess? It’s 4%ish, or even slightly higher. It’s very unlikely to still be 2-2.5%. Ergo, it is going to be very hard for the Fed to end 2023 in a happy mood…which means that it is going to be hard for investors to end 2023 in a happy mood!

Summary of My Post-CPI Tweets (November 2022)

December 13, 2022 4 comments

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but to get these tweets in real time on CPI morning you need to subscribe to @InflGuyPlus by going to the shop at https://inflationguy.blog/shop/ , where you can also subscribe to the Enduring Investments Quarterly Inflation Outlook. Sign up for email updates to my occasional articles here. Investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Check out the Inflation Guy podcast!

  • It’s #CPI Day – the last one of 2022!
  • A reminder to subscribers of the path here: At 8:30ET, when the data drops, I’ll be pulling that in and will post a number of charts and numbers, in fairly rapid-fire succession. Then I will retweet some of those charts with comments attached. Then I’ll run some other charts.
  • Afterwards (recently it’s been 9:30ish) I will have a private conference call for subscribers where I’ll quickly summarize the numbers.
  • After my comments on the number, I will post a partial summary at https://inflationguy.blog and later will podcast a summary at inflationguy.podbean.com .
  • Thanks again for subscribing! And now for the walkup.
  • Last month, the CPI was significantly weaker than expected. Against expectations for 0.5% core, we got 0.3%. Apparel and Medical Care (specifically in Health Insurance but there was weakness in other parts of Medical Care) were the main culprits.
  • However, Used Cars CPI was also more negative than private surveys had led us to believe. A decline in Airfares rounded out the list of usual and unusual suspects.
  • But on the other hand…
  • Other than Health Insurance, no services were on the “largest decliners” list. While Used Cars was droopy, New Cars inflation remained solidly positive. Rents were lower than in the prior month, but still increased at annualized monthly rates of 8.7% (Primary) and 7.7% (OER).
  • Median inflation was still +0.53%, a 6.4% or so annualized rate of increase. The Enduring Inflation Diffusion Index and other measures showed that inflation pressures remained quite broad.
  • This month, economists are calling for a repeat of softer core inflation, although the forecasts have been drifting up slightly as more economists add their estimates. Since economists like to shade vs other economists, this is like sharp money coming in on the “over.”
  • …although come to think of it, calling economists “sharp money” is probably wayyyy more generous than they (as a group) deserve.
  • Those prints (the economists’ estimates) would take y/y to 6.1% on Core (and 7.3% on headline).
  • I think the consensus is giving too much signaling weight to the deceleration in goods. It’s real, it’s important…but it is completely divorced from what is happening in services. There, we have a feedback loop in full swing.
  • Inflation leads to higher wage demands and settlements, which leads to higher inflation. Or at least, it slows the deceleration of inflation. Next year, we get an 8.7% increase in Social Security payouts, and wages are rising rapidly.
  • Median wage growth is basically steady around 6.5%ish. That’s 0.5% below median CPI, when it’s usually ~1% over. Now, I don’t think Median is about to jump another 1.5%, but another interpretation is that wage settlements suggest workers feel like 5.5% is what they’re seeing.
  • That doesn’t seem terribly wrong, and I think Median is in the process of peaking, but the point is that people are getting wage increases that in the Fed’s words are “not compatible with 2% inflation.”
  • To reiterate something I’ve been saying recently: I think the peak is in, and will show in Median CPI soon, but the real question is whether core goes back to 2%. This is ASSUMED by many economists these days. Peak=”inflation is done.” I think that’s very unlikely.
  • We also have to recognize that rents in the CPI are not going to slow soon, and I think economists are getting ahead of themselves on that one as well.
  • Yes private rent indices are declining. So? They were also skyrocketing at +18% when the CPI was not (this chart is sourced from https://en.macromicro.me).
  • That’s because only a tiny proportion of rents were turning over at those increases  The CPI was designed to capture the broad trend of expenses to consumers, NOT to mark-to-market the whole rent market. So CPI goes up less, and down less.
  • To be sure, rents are higher than my model “expected” them to be, but it’s not really egregious and I don’t expect them to slow markedly and immediately. **I think some economists are mistaking timely data for quality data.**
  • Another effect, more minor, I discussed on the private blog a week or so ago: the possibility that Hospital Services has some catch-up this month after not being reported last month. See the tweet at https://twitter.com/InflGuyPlus/status/1600503515121680384 Worth a couple of bps max.
  • So, I’m on the ‘over’ for this report, but I can make a case for a higher-than-0.4% core more easily than I can make a case for a lower-than-0.3% number.
  • Now since last month’s surprise, breakevens have dropped and so have real yields. It helps that Powell and others have basically committed to decelerating Fed hikes this month, and the market clearly believes (as do I) that they’re nearly done.
  • I don’t think this number will change that trajectory unless it’s, say, 0.7% on core or something like that. Even then, it would be very hard for the Fed to produce 0.75% tomorrow with no time to leak the change…and a quarter point wouldn’t matter much anyway.
  • BUT, if we got a crazy number then the market would immediately price a higher peak rate and push the pivot out further in the future. And stocks would get shellacked.
  • We’d need a lot of messaging pretty quickly in that case, and liquidity is very thin at this point of the year. Fortunately I don’t think we get anything that outlandish. Knock wood!
  • Good luck! Done with the walkup a bit early this month since I started early. Auto charts will follow the print fairly quickly. I still curate the charts rather than totally auto-tweet them; one of these days I’ll trust the Machine but not yet.

  • Someone is pretty sure they know the number three minutes early! Equity futures just popped 20 points.
  • …looks like he did! Weak figure.
  • m/m CPI: 0.0963% m/m Core CPI: 0.199%
  • Last 12 core CPI figures
  • Just to be clear, core at 0.2% almost exactly was the best in years. Doesn’t really feel like that when you are out shopping, IMO.
  • M/M, Y/Y, and prior Y/Y for 8 major subgroups
  • Apparel back in positive territory, which is slightly surprising. In Medical Care, Medicinal Drugs were +0.08% m/m, and Doctors’ Services +0.04%. Pretty weak, but not negative. The negative is entirely from Health Insurance and I’ve said my piece there.
  • Here is my early and automated guess at Median CPI for this month: 0.477%
  • Always a caveat here when the median category is a regional housing index. Still, it would be the lowest in more than a year although 5.7% isn’t exactly great.
  • Actually, when I calculate this using my spreadsheets I get 0.456% m/m with Recreation the median category. That would put y/y still at 7%, but slightly (very slightly) lower than last month. Fairly easy comp next month, so high might not quite be in, but pretty close.
  • Core Goods: 3.68% y/y   Core Services: 6.82% y/y
  • story here is that core services reaccelerated a tiny bit. NOT that core goods plummeted. Core goods reverting lower is something we knew already.
  • the SIZE of the core goods adjustment is what was surprising. I wonder how much of this involves early Christmas discounting. There was certainly some fear among retailers that they’d over-ordered. I don’t have an easy way to measure that.
  • Suffice to say that I’d like this number better, if it was services which had decelerated.
  • Primary Rents: 7.91% y/y       OER: 7.13% y/y
  • Further:
    • Primary Rents 0.77% M/M, 7.91% Y/Y (7.52% last)        
    • OER 0.68% M/M, 7.13% Y/Y (6.89% last)        
    • Lodging Away From Home -0.7% M/M, 3.2% Y/Y (5.9% last)
  • So, rents were HIGHER than last month, 0.77 vs 0.69 on Primary rents and 0.68 vs 0.62 on OER. This is convenient since economists have convinced themselves that they can look past this. Again, the question isn’t whether it decelerates. It’s HOW MUCH, when it does.
  • Some ‘COVID’ Categories:
    • Airfares -3.02% M/M (-1.1% Last)
    • Lodging Away from Home -0.71% M/M (4.85% Last)
    • Used Cars/Trucks -2.95% M/M (-2.42% Last)
    • New Cars/Trucks 0.04% M/M (0.37% Last)
  • Just want to say that Christmas airfares are way above normal, but nationwide fares are about right for the level of jet fuel prices. Weak Lodging Away from Home too. Note that New Cars is still rising, though weakly this month.
  • Piece 1: Food & Energy: 11.5% y/y
  • The story here continues to be that it isn’t down more than it is. Food is staying buoyant.
  • Piece 2: Core Commodities: 3.68% y/y
  • Piece 3: Core Services less Rent of Shelter: 6.33% y/y
  • It is funny to me that all of a sudden, this is the category everyone is talking about. And…it’s really not showing anything super positive, especially when you consider that health insurance is a drag. This is actually pretty bad news.
  • Piece 4: Rent of Shelter: 7.19% y/y
  • OK, so let’s hold the phone here.
  • Today’s number is a core goods story. Core goods y/y went to 3.7% from 5.1%. But core services went UP to 6.8% from 6.7%. Used cars large decline (& CPI is now ahead of private surveys a fair amount). And that’s despite health insurance, a large fall in airfares and auto rental.
  • Overall Core ex-housing (which includes core goods) is down to 5.2% y/y. That’s the lowest since…well, September 2021. Going the right direction but unless core services start to decelerate, there’s a limit to how good this picture can be.
  • So here’s the distribution story. Here is the overall distribution. You can’t tell much from this unless you have the prior chart handy. But there was a shift in the middle.
  • In red is the weight of components above 6% y/y growth. In blue, the weight of components above 5% y/y growth. This doesn’t tell you much about the monthly figure exactly but it tells you the middle of the distribution is shifting left. Still pretty high though!
  • Let’s see. Biggest monthly decliners in core were Used Cars and Trucks (-30% annualized monthly ROC), Car/Truck Rental (-26%), and Public Transport (-22%). Nothing else in the Median set declined faster than 10% at an annualized rate (Health Insurance is one level lower).
  • There were actually a lot of big gainers: Misc Personal Goods (+27%), Infants/Toddlers Apparel (+21%), Personal Care Services (+18%), Vehicle Maintenance/Repair (+17%), Communication (+13%), Jewelry/Watches (+11%), Vehicle Insurance (+11%), and the South Regional OER (+11%).
  • Lots of decliners in Recreation/Goods: TVs (-3.8% m/m), Other Video Equipment (-4.1%), Audio Equipment (-1%), Sports Equipment (-0.9%), Photographic Equipment/supplies (-1.6%), Toys (-1.8%)…see any common theme there? That looks like XMas.
  • Now, those are NSA, so some of that is the natural seasonal discounting of Christmas. But that is usually bigger in December.
  • First real pullback in the Enduring Investments Inflation Diffusion Index. So that’s also supportive of the notion that the peak is in.
  • Let me sum up. This supports the idea of a Fed taper, but I didn’t think there was much chance of derailing that unless we got a BIG number. But it’s not all it’s cracked up to be. I suspect early seasonal discounting had a lot to do with this.
  • Core services ex-rents is the fly in the ointment and will continue to be so until wages start to decelerate. No sign of that yet. I think next month we are unlikely to see another 0.2% on core.
  • But that’s not the market story. The market is celebrating because the Fed is nearly done.  Now, they are not going to start easing unless there’s a market crack-up and there’s no sign of that happening while people are happy about rates peaking.
  • The story is intact, despite the fact I was surprised by the overall figure: inflation is peaking, the Fed is nearly done…but inflation isn’t going back to 2% any time soon. *Nothing in this number suggests it is.* The sticky stuff is all still ugly.
  • To me…that’s a story of a steepening curve next year. Short rates aren’t going to go up when the Fed is sidelined but long rates will eventually have to adjust to a higher-inflation reality (and increasing deficits along with a balance sheet taper).
  • I’m going to give this summary verbally if anyone wants to listen! Call the conference number at <<REDACTED>>  Access Code <<REDACTED>>. We will start at 9:40ET (9 minutes).

This CPI print was definitely a surprise, but let’s just tap the breaks a touch. It was a one-tenth surprise on core CPI – certainly welcome, but it hardly changes the overall narrative. Let’s review the points of the overall narrative:

  1. Inflation is in the process of peaking, or has already peaked.
  2. Goods price inflation is decelerating markedly, for both demand- and supply-side reasons.
  3. Rents will eventually decelerate, of course, but private surveys seriously overestimate the degree of the deceleration and the timing.
  4. Core services ex-rents, where wage inflation lives, is going to prove sticky.
  5. All of this means that after the peak, median and core inflation will drop…but not to 2%. More like 4%-5%, where they will be disagreeably stubborn about declining further.

In today’s number, nothing in that list really changed. The deceleration in goods price inflation was sharper than I expected, but a lot of that was used cars and a lot of it were in categories that smell a lot like early Christmas discounting. Notably, rents reaccelerated from last month and core services ex-rents showed no signs of weakness.

What does this mean for the Fed? 50bps tomorrow, probably 25bps at the next meeting and possibly one more 25bps hike after that. And then the Committee stays on hold for most of the rest of 2023, unless something breaks. The bond market is pricing the former, but not the latter. The Fed is very unlikely to overreact to an 0.1% miss in core CPI, especially when their expectation is that inflation is decelerating.

So nothing really changes about the story on the basis of today’s number. I will add a few final thoughts, though. (a) part of the miss today came from Used Cars being down more than it “should” have given private surveys. That’s likely going to be a give-back in the future. (b) if part of the miss was due to early Christmas discounting, then that will come back in December or January. (c) someone really needs to look into the huge trades right before the number was released. This wasn’t an accidental post on the website. And you don’t put that much money into an illiquid market on a guess. Someone knew something. Do I expect anyone to investigate? Not really.

Summary of My Post-CPI Tweets (October 2022)

November 10, 2022 Leave a comment

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but to get these tweets in real time on CPI morning you need to subscribe to @InflGuyPlus by going to the shop at https://inflationguy.blog/shop/ , where you can also subscribe to the Enduring Investments Quarterly Inflation Outlook. Sign up for email updates to my occasional articles here. Investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Check out the Inflation Guy podcast! Note that this month and going forward, I will be delaying the drop of this tweet summary and the podcast until the afternoon rather than dropping it late morning. So subscribe if you want it live!

  • It’s CPI Day – and here we go again!         
  • A reminder to subscribers of the path here: At 8:30ET, when the data drops, I’ll be pulling that in and will post a number of charts and numbers, in fairly rapid-fire succession. Then I will retweet some of those charts with comments attached. Then I’ll run some other charts.      
  • Afterwards (hopefully 9:15ish) I will have a private conference call for subscribers where I’ll quickly summarize the numbers.    
  • Thanks again for subscribing! And now for the walkup.  
  • The chance of more-lasting inflation just went up a lot. With the much-narrower-than-expected margins for the Republicans in the House – and perhaps no margin at all in the Senate – this is “divided government” IN NAME ONLY.     
  • Republicans are notoriously bad at whipping their vote, and with a narrow margin it will be very easy to pick off a couple of votes with well-chosen pork to pass large stimulus measures if the Democrats want it. And they probably want it.             
  • And why shouldn’t they want it? The Republican message in the midterms was “Biden caused this inflation and we voted against the Inflation Redution Act.” The Democrat message was “Putin caused this inflation and we PASSED the Inflation Reduction Act.” Evidently, that resonated.          
  • Politicians will keep pushing MMT as long as the populace allows them to get away with it. And with such a narrow majority, Republicans can probably not ‘hold the line.’ Ergo, there will be more stimulus ahead.  
  • To say nothing of other continuing pressures, on resources & a need to shorten supply chains as the world fractures the post-Berlin-wall detente. To say nothing of demographic challenges. To say nothing of the fact that prices still have far to go to catch aggregate M2 growth.      
  • Those are not stories for the October CPI, but they are the backdrop.      
  • I was at a conference the last 2 days and several mainstream economists stated (it was barely phrased as an opinion) that core inflation will definitely be around 3% by middle of next year and low 2s by end of 2023.               
  • This seems ignorant of the composition of the CPI. EVEN IF you think inflation pressures in a macro sense are ebbing, we haven’t yet seen any signs of that in the data. Y/Y median CPI has accelerated 14 months in a row. Rents remain buoyant. 
  • Rents will eventually slow, but it will be a while before they slow very much. So far they are still accelerating! And core-services ex-rents is my recent focus. As a reminder, that’s where you find the wage-price feedback loops. And it has recently started spiking higher.
  • But there is a potential fly in the ointment in that group this month, and that’s the question about the CPI for health insurance. Here is the issue that some people are worried about.
  • Medical care is paid for by consumers directly, and indirectly for consumers by insurance companies. It is straightforward (if complex) to measure the part of medical care paid directly to providers – just ask doctors and hospitals.
  • The problem is that there is a difference between what insurance companies receive from consumers (which is part of consumers’ cost) and what they pay to doctors. That is, profit.
  • That’s still a cost to consumers but not captured if you just ask doctors. It shows up in the “Health Insurance” part of Medical Care CPI. So, periodically (because it’s not at all straightforward) the BLS tries to figure out this difference and adjust for it.
  • It tends to happen roughly this time of year, which is why people were looking for it last month and still looking for it this month. Here’s the problem – it isn’t always important.
  • You can see in the m/m changes in Health Insurance that sometimes there’s a discontinuity in the monthly figures, and sometimes not. Here’s the salient point, though – the adjustment doesn’t really matter.
  • If it’s done right, then the overall inflation in Medical Care will be about right. Could be seasonal issues, so any given month it could be wacky, but the REAL question is: is inflation in Medical Care overall accelerating/decelerating? Sure looks to me like it’s accelerating.
  • So I don’t pay a lot of attention to this nuance but be aware that it COULD have an impact potentially today.
  • Last month, big drivers were Rents again (primary=0.74%, OER=0.71%), Medical Care (0.68%, with Hospital Services 0.78% m/m and y/y Prescription Drugs at 3.2%, highest since 2018). Oh, and “Other” at +0.73%.
  • Inflation is of course very broad, and that means it is going to keep being pretty resilient. Until one day it starts narrowing and being less resilient. There’s no good way to say when rents will roll over. They will eventually. Probably not today.
  • But breakeven market is being very optimistic generally about this eventual occurrence! There’s almost no penalty to betting inflation will NOT go back to its old level. Or at least, a pretty small one.           
  • Used cars this month will again be heavy, but probably not as heavy as last month’s -1.1%. Used car prices have retreated (in the Black Book survey) about 12% from the highs but remain up about 35% since end of 2020. That’s about the same as M2, so it’s roughly “right”.       
  • Of course not everything will be up the same amount as the general price level, but that’s a decent touchstone. On average, once velocity finishes correcting back, the aggregate price level should be +30%-+35% (based on current M2) from 2020. Currently +15%. Long way to go.
  • Markets since last month: breakevens are up a bit, but real yields close to unchanged. Reals are pretty close to a long-term fair level. They’ll go higher if nominals go higher but they’re a pretty decent deal esp relative to nominals given the long term breakevens.
  • …and the nominal auction yesterday was pretty ugly, so I don’t know that the fixed-income bears are done. I suspect the Fed is getting close, though. My guess for terminal rate is currently 5%.          
  • Econ consensus for today’s CPI is 0.62% m/m on the headline and 0.47% m/m on core, bringing y/y core to 6.52%. With the medical insurance issue I’m reluctant to hazard a guess but 0.47% seems optimistic. Avg for last 6 months has been 0.56%. But interbank is LOWER than 0.47%.         
  • In any event, good luck! Auto charts will follow the print fairly quickly. I don’t know how many months I will be doing this before I stop being nervous about the automation. But I throttle those charts still to make sure that if something looks wrong it isn’t followed by 9 more.

  • m/m CPI: 0.438% m/m Core CPI: 0.272%       
  • OK now let’s look at these. Obviously the core figure was a disappointment but I can already see it’s not something I’m terribly worried about and not likely to signal that we’re done. That said, it should be a nice rally number.     
  • Last 12 core CPI figures        
  • Primary Rents: 7.52% y/y OER: 6.89% y/y     
  • Further: Primary Rents 0.69% M/M, 7.52% Y/Y (7.21% last) OER 0.62% M/M, 6.89% Y/Y (6.68% last) Lodging Away From Home 4.9% M/M, 5.9% Y/Y (2.9% last)
  • Well, 0.69% m/m is better than last month’s 0.84% on primary rents, but not exactly the deflation that people are expecting to happen ‘soon.’ Soon, it seems, is still a bit far away.
  • M/M, Y/Y, and prior Y/Y for 8 major subgroups          
  • Immediate observation – huge decline in Apparel (yes, a small weight) and in Medical Care (which I suspect is the technical adjustment). Housing, Food, Other, Recreation, all high.
  • Here is my early and automated guess at Median CPI for this month: 0.613%
  • Median: definitely better than recently! but a 7.6% compounded annual median rate isn’t GOOD news. And it suggests that most of the miss was in a few categories, not the main body of the distribution.
  • By the way, a little asterisk on my median calculation – I have the median category as West Urban OER. Since the individual components of OER are seasonally-adjusted (but we don’t know the seasonals), my estimate will be slightly off.
  • Core Goods: 5.08% y/y Core Services: 6.74% y/y        
  • And you can see the effect of Apparel (and Used Cars, which was down more than I expected it would be and more than Black Book suggested it would be) on core goods. This is partly a delayed dollar effect, and some supply-side relaxation, and not surprising in a macro sense.
  • Some ‘COVID’ Categories: Airfares -1.1% M/M (0.84% Last) Lodging Away from Home 4.85% M/M (-1.04% Last) Used Cars/Trucks -2.42% M/M (-1.07% Last) New Cars/Trucks 0.37% M/M (0.67% Last)           
  • So Used Car prices are coming down, and New Cars still going up. Remember in mid-2021 Used Car prices in some cases exceeded New Car prices b/c New weren’t available. They are now, so this is the convergence. Used is correcting, New is trending.
  • Used cars on top, New Cars on bottom, since day 1 of COVID. New have another 10% to go higher, Used another 15% lower, is my guess.
  • Piece 1: Food & Energy: 13.3% y/y   
  • Piece 2: Core Commodities: 5.08% y/y          
  • Piece 3: Core Services less Rent of Shelter: 6.42% y/y              
  • The y/y for health insurance went from 28.1% to 20.6%. Obviously, those numbers are way too high. But it caused the y/y for Medical Care to drop from 6% y/y to 5% y/y. This seems exaggerated.
  • Now, to be sure Medicare is dropping the amount that it is reimbursing health care providers. But Medicare is not in CPI and a squeeze on Medicare reimbursements may make the consumer part of health care more resilient. Got to pay health care providers somehow.
  • Piece 4: Rent of Shelter: 6.99% y/y  
  • No sign of any slowdown in rents yet. And without that, we’re not getting 2% inflation next year, period.
  • That really was an amazing adjustment to health insurance. I applaud those who decided it was going to be huge. Again, though, it’s just a question of how Medical Care inflation gets allocated. And it’s a one-off thing.          
  • Outside of food and energy, the biggest monthly decliners were Infants and Toddler’s Apparel (-32% annualized), Jewelry and Watches (-30%), Used Cars and Trucks (-25%), and Footwear (-13%). No services. OTOH…             
  • Biggest gainers were Lodging Away from Home (+77% annualized), Misc Personal Goods (+26%), Vehicle Insurance (+23%), and Food Away from Home (+11.8%). That last one is obviously Food & Energy but it’s also a wages indicator.
  • Looking at Median some more, probably the lowest it could be (if my West Urban OER seasonal is way off) is 0.55%. And could also be higher than my estimate. 
  • Core inflation ex-housing fell to 5.9% from 6.7%. That’s the lowest it has been since 11/2021. And it’s a good sign. A lot of that is goods.            
  • The deceleration in goods inflation is completely real. But that doesn’t mean goods prices are going to go DOWN, which is what consumers are expecting. Some places where there were overshoots like in Used Cars will go down, but in most cases we’re talking small.             
  • Here’s the challenge on the Fed question. I wouldn’t take a victory lap even though this is the lowest core m/m in more than a year. Median has still not obviously peaked! Next core comps are 0.52%, 0.56%, 0.58%, 0.50% before 0.32% in March.       
  • That means we are probably looking at core which will be steady to declining slowly, but not coming down rapidly. There aren’t 0.6s or 0.7s to roll off until May. So it will look like a peak but not a rapid drop. Unless of course rents roll over and drop like a stone.
  • OR, suddenly workers start getting wage cuts. Keep in mind that the Social Security adjustment for next year will flush a lot more money into the system. There’s just a lot of bad feedback loops that are in play.
  • By the way, Lodging Away from Home was high (+4.9% m/m) this month. That’s a volatile category but surprised me. Hospitality is having difficulty with finding workers though and so this is another one of those pass-throughs I suspect.      
  • Here’s the distribution of lower-level price changes y/y. It’s an interesting tale. The lower tail are mostly goods (insurance won’t be there for a long while), upper tail has some foods and some services. The middle part is still 7-9%.
  • Having said that, this is starting to look more like a disinflationary distribution where the mean is below the median because long tails start showing up to the lower side. I think we’ve likely seen the peak, although Median will take a bit yet.
  • I mean we still have 65% of the distribution above 6%…        
  • That health care insurance adjustment is odd. Normally the BLS smears the adjustment over 12 months roughly equally. I can’t imagine this is going to be 4% PER MONTH for a year. That would be really weird. Something to dive deeper on. For now I’m treating it as one-off.   
  • Last chart. I didn’t run this last month because of tech issues. The EI Inflation Diffusion Index remains high but dropped to 41. It’s not yet really signaling a peak in pressures but if we get down to 30 or 35 I’ll feel better that the peak is real.       
  • OK, let’s try the conference call for anyone who wants to hear this verbally. 🙂 [REDACTED] Access Code [REDACTED] Let’s say 9:35, 5 minutes from now.       

The number today made a lot of folks very happy, but it is a trifle early to declare victory over inflation yet. Core goods remains in deceleration mode. This is no surprise; the extended strength of the dollar helps depress core goods prices with a lag. The sharp drop in apparel prices is sort of the poster child for this effect. But the dollar will not be strong forever, and when it goes back to something like fair value – when the Fed stops hiking aggressively relative to the rest of the world – then there will be a little payback in this category. That doesn’t mean 10% core goods inflation but neither does it mean that we’re going back to the old normal of -1% inflation in core goods year after year. Given the re-onshoring trend and the general unsettled nature of geopolitics, I suspect core goods will end up oscillating around low-positive numbers. Think 1-2%, not -1% to -2%.

Rents remain strong, and there is no sign that they’ve rolled over yet. They will eventually, but it takes a long time for rents to reflect changes in home prices and even longer for asking rents to be fully reflected in rent CPI and OER. Rents will decelerate from here, but not for a while. And they’re also not going back to 2%.

Core services ex-rents is in a continued uptrend. There was a small correction this month, but the feedback loop has been triggered. Next year’s Social Security adjustment will throw more fuel on the fire, and even if unemployment rises so that real median wages decelerate nominal wages are going to keep climbing faster than they have historically. Core services ex-rents…and we saw similar effects in Lodging Away from Home and Food Away from Home, both of which have a big wage component…is going to stay strong for a while.

By the way, on Medical Insurance…that 4% per month drag over the next year is going to add up to 0.3% on headline and a bit more than that on core. But only if this isn’t offset elsewhere in the medical care category. This is bean-counting: insurance in the CPI doesn’t really measure the cost of insurance premiums but insurance company profits. If our estimate of profits declines it’s either because people are paying less for insurance (not likely) or because insurance companies are paying more out to doctors, which means the inflation should just show up there instead. So it will be a consistent drag that is mostly irrelevant in a practical sense.

All of which is to say that while core CPI has likely peaked, and median inflation will probably peak in a few months, the folks who are looking for it to drop to 2% next year are going to be terribly disappointed. I’m sticking with my view that we will be at high-4%, low-5% for 2023.

The Fed, though, will take the peak in Core as a reason to step down to 50bps at the next meeting, then probably 25bps, and ending at around 5%. If rates are at 5% and median inflation is around the same level late next year, it isn’t clear that much higher rates would be called for especially in a recession. But neither will much lower rates. So I think overnight rates get to 5% and then stay stuck there for a while. If you found this useful, and would like to get it in real time during next month’s CPI report, go to https://inflationguy.blog/shop/ and subscribe to my private Twitter feed. You can also subscribe to my quarterly, or purchase a single issue of the Quarterly Inflation Outlook (either current or historical). Thanks a lot for your support.

Summary of My Post-CPI Tweets (September 2022)

October 13, 2022 8 comments

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but to get these tweets in real time on CPI morning you need to subscribe to @InflGuyPlus by going to the shop at https://inflationguy.blog/shop/ , where you can also subscribe to the Enduring Investments Quarterly Inflation Outlook. Sign up for email updates to my occasional articles here. Investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Check out the Inflation Guy podcast!

The tweets below may have some deletions and redactions from what actually appeared on the private feed. Also, I’ve rearranged the comments on the charts to be right below the charts themselves, for readability without repeating charts, although in real time they appeared in comments associated with a retweeted chart.

  • It’s CPI Day – and here we go again!
  • A reminder to subscribers of the path here: At 8:30ET, when the data drops, I’ll be pulling that in and will post a number of charts and numbers, in fairly rapid-fire succession. Then I will retweet some of those charts with comments attached. Then I’ll run some other charts.
  • Afterwards (hopefully 9:15ish) I will have a private conference call for subscribers where I’ll quickly summarize the numbers.
  • After my comments on the number, I will post a partial summary at https://inflationguy.blog and later will podcast a summary at inflationguy.podbean.com . Busy day for the IG.
  • Thanks again for subscribing! And now for the walkup.
  • Last month, we again had a large upward surprise. Median CPI actually had its highest m/m print of the entire debacle-to-date. While y/y numbers are the big focus in the media, until we have a convincing peak in Median CPI we can’t really say the inflation pressures are receding!
  • Median CPI has moved back above core; this means that for the first time since April 2021 the longer tails are to the downside (the distribution skews lower, so the average is lower than the median).
  • If this is still true once inflation levels out a little bit, it will be encouraging. In inflationary cycles, the outliers show up on the high side and core moves above median. In disinflationary cycles, the opposite is true. Let’s give it some time and see what happens.
  • Rents in last month’s report were big, and though Used Cars set back a little bit New Cars had a big up. But the BIG eye-opener was the rise in core services less rents.
  • I wrote last month: “If core services ex-shelter is really taking the baton from core goods, that’s really bad news. Because core services ex-shelter is where wage pressure really lives. If you want a wage-price spiral, look in core services ex-shelter to see if it’s happening.”
  • So that is my main focus in this report. More later but let’s look at the consensus figures going in. Consensus for headline CPI is 0.21%/8.09%, while consensus for core CPI is 0.43%/6.52%. That will be a small acceleration in core (again).
  • For my money, the implied drag for food and energy (0.22%) looks slightly too large, and the interbank market seems to agree with an implied headline number of about 0.26% m/m. But I also think the core might come in a teensy bit lower than 0.4%.
  • I don’t know if what I am looking at would be enough to round it lower, but an 0.3% core print would make the markets very excited and COULD make the Fed favor a smaller move at this meeting. Not only because of 0.3%, but because things are starting to break.
  • …and the Fed’s models say that inflation should be slowing, so…why not taper the tightening? I think we MIGHT be having that discussion later this morning.
  • Certainly, the mkts have let the Fed go pretty far without throwing up a stop sign. 2y rates +72bps in the last month and 10y rates +54bps? Tens at 3.90% are pretty close to a long-term fair number (still a trifle low) after YEARS of being too low. Naturally, we could overshoot!
  • The decline in forward breakevens is very curious – I don’t see any sign that 2.25%-2.5% as a long-term equilibrium is still the attractor we will drift back to. The fun house mirror is broken for good I think.
  • So where do I see some potential softness? Our models have rents leveling off – not peaking per se, but leveling off – and that means that a trend projection of last month’s number might be overdone. Of course, those are just models.
  • More important (and obvious to many) is the decline in Used Cars prices. Last month, Used were a small drag but New cars added a bunch. We could still get the bump in New, but Used ought to be a decent drag based on the Blackbook figures.
  • But as an aside, this goes back to the error being made by a whole lot of people and politicians especially. See that last chart? Does it say “used car prices are coming back down and reverting, now that supply chain issues have cleared up? NO.
  • It’s a mistake, the same one people are making in rents & home prices. Rates of change could mean-revert. Prices will not. Prices are permanently higher, b/c the amount of money in the system is permanently higher. This chart shows the price level. Not going back to the old days.
  • Politicians saying inflation should ebb soon SEEM to be telling constituents that prices are going back down. At least, that’s what the constituents hear. They will be mad when the politicians say “see?” and they see all prices 30% higher than pre-COVID.
  • (I actually think something similar may be the root of a lot of conspiracy theories about how the government ‘cooks’ the numbers. They’re just talking past each other, with one talking price level and one talking rate of change.)
  • And speaking of money in the system – money supply growth has come to a screeching halt over the last few months, which is great news. Unfortunately, we are still catching up to the prior increase in money, which is why it will take a while for inflation rates to come back down.
  • There’s still work to do. Anyway, a lot of that is wayyyy beyond the trading implications for today’s figure. The key for me is to look past used cars and rents, and look at CORE SERVICES EX RENTS. That’s one of our “four pieces” that you’ll see in a few minutes.
  • If there’s softness in core, it will be taken well by both stocks and bonds and while I might fade stocks in a day or two, I’m not sure I’d fade a rate rally at least at the short end. If I’m wrong, and the core number is HIGHER…it could get pretty ugly. Liquidity is bad.
  • That’s all for the walk-up. Ten minutes until kickoff. Good luck today and thanks again for subscribing! Charts will launch a minute or two after 8:30, assuming data drops on time at the BLS.

  • welllllp. Not soft!
  • m/m CPI: 0.386% m/m Core CPI: 0.576%
  • Further: Primary Rents 0.84% M/M, 7.21% Y/Y (6.74% last) OER 0.81% M/M, 6.68% Y/Y (6.29% last) Lodging Away From Home -1% M/M, 2.9% Y/Y (4% last)
  • Last 12 core figures. About the same as last month. And if you exclude the two little dips, the other 12 are all pretty much 0.58% ish. That’s uncomfortable stability! Don’t want to see that. Comps get tougher going forward so core might not go up much more…but no sign of down.
  • Here is my early and automated guess at Median CPI for this month: 0.667%
  • Now, Median stepped down so that’s good news…but 0.667% m/m is not terrific. This is still the third-highest m/m in the last 40 years or so!
  • M/M, Y/Y, and prior Y/Y for 8 major subgroups
  • In the major subgroups, the drop in apparel stands out. The dollar’s strength is definitely affecting goods prices, and Apparel is one place where we see that most clearly.
  • Core Goods: 6.63% y/y Core Services: 6.65% y/y
  • It’s cute to see Core Goods and Core Services kissing. We know that goods are eventually going to go back down to 0-3%…especially if the dollar remains strong.
  • Primary Rents: 7.21% y/y OER: 6.68% y/y
  • This is a surprise – a further acceleration in rents. Economists might look past this, because with home prices leveling off rents won’t keep shooting higher and higher. Will they? Our model has a peak happening but if wages keep rising then rents need not decline, just slow.
  • Some ‘COVID’ Categories: Airfares 0.84% M/M (-4.62% Last) Lodging Away from Home -1.04% M/M (0.08% Last) Used Cars/Trucks -1.07% M/M (-0.1% Last) New Cars/Trucks 0.67% M/M (0.84% Last)
  • In the covid categories, Used Cars was in fact a drag. And New Cars was in fact a bump higher. There have been some big stories recently about markups for new trucks etc so this isn’t a surprise. But again, core goods will eventually decelerate.
  • Piece 1: Food & Energy: 14.2% y/y
  • Again Food & Energy is decelerating, but again it’s not as much as expected BECAUSE food, which we ordinarily mostly ignore, keeps rising. 10.8% y/y on Food & Beverages!
  • Piece 2: Core Commodities: 6.63% y/y
  • Piece 3: Core Services less Rent of Shelter: 6.62% y/y
  • Soooo…this is the piece that’s sort of ugly and I was worried about this. Core services less rent-of-shelter continues to accelerate. Medical Care was another 0.77% m/m, with Hospital Services 0.66% m/m. I’ll look at some of the other categories in a bit.
  • Piece 4: Rent of Shelter: 6.68% y/y
  • Core ex-housing (not just core services ex-housing) rose to 6.7% y/y. It had gotten as low as 6.04% two months ago but is reaccelerating. We know core goods is decelerating so the upward lift is core services ex-housing. And as I noted, that’s bad.
  • I forgot to mention that the median category was New Vehicles. As always with my Median CPI estimate, I caution that I have to estimate the seasonals on the OER subindices and if I’m off, and an OER category is near the median, then my Median guess might be off too.
  • Food AT HOME was 0.6% m/m (SA), 12.98% y/y. That’s slightly lower than it has been. Food AWAY FROM HOME, though, was +0.94% m/m, 8.48% y/y. This is bad – food commodities are leveling off a little, but wages show up in food away from home.
  • This number could have been worse. Airfares being -4.62% m/m helped. Airfares are largely driven indirectly by jet fuel, but had been positive last month so this is a catch-up. However, jet fuel is probably not going to go down much futher.
  • Conclusions: (a) this number is worse than expected. And not from little ‘I don’t care’ one-off things. (b) Where wages show up in the economy, we are seeing more inflation pressure show up in CPI. That’s not evidence a wage-price spiral has begun, but it is suggestive.
  • (c) since in yesterday’s FOMC minutes, participants had been musing about the risk of a wage-price spiral, this is especially salient right now. (d) This seals 75bps. They won’t do 100bps, and this report doesn’t let them do 50bps.
  • (e) This MAY raise the terminal rate. We will get more inflation data, but median CPI isn’t showing a deceleration and the m/m core is pretty solid at a 7%-ish rate (0.58%/mo) with occasional dips. Need at least 2 dip months.
  • (f) The deceleration in core goods is already happening. It has been happening. The dollar’s strength will help it to continue. But the acceleration in core services is more durable and not dollar-sensitive.
  • (g) it’s also not particularly rate-sensitive. (h) Higher wages also support higher rent growth. I am surprised at the extent of the strength in rents but put that (somewhat) in the wage-price spiral camp.
  • And finally (i) inflation markets are ridiculously mispriced. There is no reason to think that 2.25%-2.5% is the fair bet for 10-year inflation, especially when it’s going to be at 5% or above for the first 2 years of that 10 years. This is going to take a while.
  • I’m going to do a quick call right now and present my thoughts. Dial-in is <<redacted>> and Access Code <<redacted>>.
  • I will throw another housing-related chart here. Here is OER in red, against two home-price indices that are often used to model rents as a lagged function of home prices. The leveling-off should happen soon. BUT>>
  • …BUT the betas have changed and OER is higher than we would have expected based on the prior relationship. Those regressions were all based on nominal changes, not real…part of home price increase should be pass-through of value of real property, greater when infl is higher.
  • Either way, the timing suggests we should level off, and if you believe this model then in 6-12 months rents should be in sharp retreat. Maybe. But like I say, things have changed from the 2001-2020 baseline!

We keep waiting for a clear turn in inflation, and it hasn’t happened yet. Moreover, the longer it lasts then the more likely that it feeds back into wages, since workers have more and more evidence to take to the bargaining table when it’s time to discuss increases. Some of the feedback loops are purely automatic: For example, on the basis of today’s figure Social Security benefits next year will jump 8.7%, giving retirees an additional slug of cash to spend next year. That automatic adjustment also creates a feedback loop in deficits, of course – that big increase in benefits will also increase federal outlays! So, if you were hoping to balance the budget rather than pour more fuel on the fire…it just gets harder and harder.

The slight drop in m/m median CPI is nice, but not sufficient to signal that inflation pressures have turned. For a very long time, everyone else was surprised with the resilience in inflation and I was not – but now I’ve joined the ranks of those who are surprised. I haven’t thought, and do not think, that inflation will fall back to 2% any time soon, but I also didn’t think it would keep accelerating into year-end. I still don’t think that. But…it’s also hard to see where the deceleration is going to come from. Our models (and the final chart above) give reason to think that rents might level off from here, but not decelerate much; core goods will continue to retreat but core services seem to have a feedback loop going. The fact that food away from home is accelerating while food at home is correcting slightly is emblematic of the passing of the torch from raw materials pressures to wage pressures. This is not good.

That being said, and while 75bps is pretty much cemented now at the next Fed meeting, I still think that the FOMC is looking for reasons to slow the pace of hikes. Things are starting to break around the world, and there’s no appetite (I don’t think) to test the limits of the system’s fragility right now. But the balance sheet is going to continue to shrink slowly, and that’s a big part of the decline in market liquidity. Certainly, the market has been generous with the Fed so far and hasn’t offered them the Hobson’s choice of saving the markets or pushing inflation lower…but that choice is going to come sooner or later especially as inflation has not yet shown any real signs of slowing down.

And yet, as I write this the stock market has closed the gap by rallying up to yesterday’s closing level, and is spiking higher. That’s remarkable, and I think it’s fadeable!

Summary of My Post-CPI Tweets (August 2022)

September 13, 2022 7 comments

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but to get these tweets in real time on CPI morning you need to subscribe to @InflGuyPlus by going to the shop at https://inflationguy.blog/shop/ , where you can also subscribe to the Enduring Investments Quarterly Inflation Outlook. Sign up for email updates to my occasional articles here. Investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Get the Inflation Guy app in your app store! Check out the Inflation Guy podcast!

The tweets below may have some deletions and redactions from what actually appeared on the private feed. Also, I’ve rearranged the comments on the charts to be right below the charts themselves, for readability without repeating charts, although in real time they appeared in comments associated with a retweeted chart.

  • Back to CPI Day – my favorite day of the month. Yours too? I’m glad.
  • A reminder to subscribers of the path we take today: First the walkup; then at 8:30ET, when the data drops, I’ll be pulling that in and will post a number of charts and numbers, in fairly rapid-fire succession.
  • I will put replies to those charts as necessary. Then I’ll run some other charts. What I will NOT be doing this month is the live commentary. Last month, that actually slowed everything down because of the multitasking.
  • So instead, afterwards (hopefully 9 or 9:10ish) I will have a private conference call for subscribers where I’ll quickly summarize the numbers. Not sure if that’s valuable, but we’ll try it.
  • After my comments on the number, I will post a partial summary at https://inflationguy.blog and later will podcast a summary at http://inflationguy.podbean.com . And all of that also will be linked on the Inflation Guy mobile app.
  • Thanks again for subscribing! And now for the walkup.
  • There was a talking head this morning saying “we should only care about the sequential number, not the y/y number. Those usually say the same things but not recently. And the sequential number is fresher” (I’m paraphrasing).
  • Couple of things wrong with this statement but I will focus on the main one: there is no planet on which one economic data point should matter overmuch to your view.
  • Can one number refute your null hypothesis? These are experiment results, samples from a distribution we can’t know. One data point would have to be wildly different than your null, and if it was then you’d suspect there is some quirk in the data.
  • For example, that’s what happened last month: median CPI printed again a little above 0.5%, but there was a very low headline number (because of gasoline) and a very low core because of large movements in small categories.
  • Large moves in small categories aren’t likely to be repeated, and they don’t tell you a lot about the overall distribution. They are more likely to be mean-reverting than trending. They shouldn’t change your view much, especially since Median is still rising at >6% pace.
  • The other issue with what he said is: the real question isn’t whether inflation is accelerating or decelerating. It is decelerating, and so the y/y number will decline. Most of the deceleration is in core goods. That has been expected for some time. Partly ports, partly dollar.
  • The real question is: will we recede on core/median to 2.5%, or 5%? I think it’s closer to the latter than the former, and not until next year, but there is no way that ONE NUMBER could really answer that.
  • So I care about sticky, I care about whether we are seeing a new uptrend in core services, I care about rents. I don’t care so much about lodging away from home.
  • Now, that doesn’t mean we should ignore this number. Indeed, to me it seems that expectations for this number have swung really to the low side. Both in economist land and in trading land.
  • Here is a chart of changes over the last month. Large declines in breaks at the short end – although to be fair a decent part of that is carry. But the optics influence the forecasts of those who don’t really dig into the guts, and that might be an opportunity.
  • Forecasts to me look low. Consensus is -0.1% on headline, +0.3% on core. The y/y forecast for core is 6.1% (which tells us that the real forecast is 0.32%-0.34%. Any higher and m/m rounds to 0.4%. Any lower and the y/y rounds down to 6.0%.)
  • That seems low. Last month’s 0.31% on core was infected by a lot of one-offs. Airfares -7.8%, Lodging away from home -2.7%, car/truck rental, etc. But primary rents were 0.7% m/m, and OER 0.63% m/m. So how do we get another 0.32% on core?
  • Well, you COULD get a retracement of some of the rents rise last month. That’s really the only thing I’d worry about. Some of the drops from last month may retrace (although core goods deceleration is real). But 0.3% seems sporty, especially with median still where it is.
  • The core/headline spread looks to me like it should be about -0.36%, so if we get 0.4% on core then we could print a small positive on headline. I think that’s where the risk is, unless rents are way off.
  • Used cars will drag a bit again this month, but it won’t be large.
  • I should say the interbank market is more in line with me than with economists. 295.71 NSA traded yesterday. That would be an NSA m/m decline, and a small positive SA.
  • The real question is the Fed’s reaction function. And I think their reaction to THIS number is basically nil. They’re going to go 75bps at the next meeting because the market has validated that level. The question is NEXT meeting; that will depend on how markets are behaving.
  • The Fed BELIEVES they are close to done, which is why Powell can make a vacuous “until the job is done” statement. The job (shrinking the balance sheet) has barely started, but they may be close to done on short rates.
  • Because if they’re ahead (and they think they are), at some point they need to pause to see the effect of their actions to date.
  • For today, there may be downside equity risk if the number is a little higher as I expect. But if it’s as-expected, there may be UPSIDE risk…probably fadeable, but I think the market reaction function and the Fed reaction function may be diverging.
  • So I know what I’m going to do when the number prints what the number prints, but I am less sure of what the market is going to do. Kinda feels there is still downside to equities. With real rates where they are, equities still look expensive (chart uses our equity return model).
  • OK, that’s all for the walkup. Number in 10 minutes. Good luck!

  • oooops
  • M/M, Y/Y, and prior Y/Y for 8 major subgroups
  • Food and beverages still rising. 0.77% m/m and 10.9% y/y! All other subindices contributed. “Other” was +0.73% m/m so that will be interesting. Medical Care +0.68% and that is also going to be interesting/disturbing.

  • Here is my early and automated guess at Median CPI for this month: 0.738%
  • Look at the median chart. This is just an estimate, and depending what the median category is it might not be precisely right…but if it is, then the 0.738% m/m is a new high for the m/m. OUCH.
  • Core Goods: 7.06% y/y Core Services: 6.07% y/y
  • Core goods actually went UP y/y, just a tiny bit, 7.06%. And core services continuing to rise, 6.07%. Convergence at 6.5% is not what people were hoping for.
  • Primary Rents: 6.74% y/y OER: 6.29% y/y
  • Further: Primary Rents 0.74% M/M, 6.74% Y/Y (6.31% last) OER 0.71% M/M, 6.29% Y/Y (5.83% last) Lodging Away From Home 0.1% M/M, 4% Y/Y (1% last)
  • Primary rents 0.74% m/m. OER 0.71% m/m. That’s the big ouch. I read this morning on Bloomberg I think that ‘rents are near a peak.’ Uh, sure. Lodging Away from Home was positive…didn’t retrace last month’s drop, but didn’t repeat it either.
  • I mean, this is a little scary, right? No sign of a peak yet.
  • Some ‘COVID’ Categories: Airfares -4.62% M/M (-7.83% Last) Lodging Away from Home 0.08% M/M (-2.74% Last) Used Cars/Trucks -0.1% M/M (-0.41% Last) New Cars/Trucks 0.84% M/M (0.62% Last)
  • Airfares keep sliding, but again a lot of this is jet fuel. As has been pointed out elsewhere, if you quality-adjust airfares then inflation is still soaring. Used cars was a small drag, as expected. But look at new cars!
  • The rise in new cars is probably the reason that core goods advanced. 0.8% m/m in new cars is impressive.
  • Piece 1: Food & Energy: 15.7% y/y
  • Only surprise here is that it isn’t retracing nearly as much as people expected. You know why? FOOD. When was the last time we really worried about food prices driving the CPI?
  • Piece 2: Core Commodities: 7.06% y/y
  • Piece 3: Core Services less Rent of Shelter: 5.75% y/y
  • This is even more concerning than the shelter numbers, in my mind. I’ll dig deeper into medical care, but this has been a well-behaved part of CPI for a long time. BUT IT’S WAGES. That’s what matters in this group. This is where your wage/price spiral would show up.
  • Piece 4: Rent of Shelter: 6.31% y/y
  • So 0.12% on headline (SA), 0.57% on core. Not exactly what the market was expecting.
  • Yeah, so I guess last month were one-offs. But those of us “in the know” knew that, right?
  • Last 12 core CPI figures
  • Stocks are NOT happy with this. And that’s no surprise! But it’s not because the Fed is going to go 100bps this month. They won’t. It’s because suddenly “maybe they’re not as close to done as we thought.” More on my thoughts about the Fed later.
  • I need to run some of my slower charts now but looking at markets the only quirky thing – I understand the market but it’s weird – is that energy prices are down. The theory is that more Fed hikes slow the economy more, but if you’re connecting growth and inflation then>>
  • …you’d have to also say that growth must be stronger than we think. Energy is confusing nominal and real prices again, too. Maybe it’s a dollar thing. Dollar is definitely stronger as Fed arc is perceived higher now.
  • …but it’s a weird idea that the more inflation you get, the more you want to sell commodities, isn’t it?
  • Core ex-shelter rose to 6.36% from 6.04%. Back to the level of May. Hard to tell on this chart. This will probably continue to decline, but…this is the really surprising part of the report. Going to get to the smaller stuff in a bit and see what’s up.
  • Car and Truck rental was -0.5% m/m (NSA)…it was a big drop last month as well. Interesting and not sure what that means.
  • No other interesting declines. On the upside was New cars…at 4% of the basket, that was 3-4bps of the surprise roughly. Not enough to explain it all!
  • Lots of other motor vehicle stuff. Maintenance and repair, insurance, parts and equipment…all rose at greater than a 10% annualized pace.
  • Also…south urban OER rose 0.9% m/m or so. So rents and prices are rising in the south, but not falling in the north. Some of that is migration. The median category was Rent of Primary Residence, which as noted was large.
  • With the median as Primary Rents, my 0.74% m/m median guess is probably pretty solid. That takes y/y median to 6.7% I believe. yowza.
  • Medical Care…Prescription Drugs +0.36% m/m (NSA). Dental Services +1.31%. Hospital Services +0.78%. YES. I’ve been wondering where this was for a long time. Still only up to 4% y/y, but it’s way overdue.
  • Similarly, prescription drugs…3.2% y/y, highest since 2018. I wonder if the determination that Medicare will ‘negotiate’ more drug prices is leading manufacturers to hike prices in advance?
  • OK…college tuition and fees, +1.3% m/m. That’s not unusual for the NSA to jump in this month; tuition jumps once a year basically. But that means the y/y change is going to move higher as the SA adjustment is smoothed in. Now it’s at 2.79% up from 2.35%.
  • Colleges have cost pressures too. And wage exposure. Over the last few years tuition inflation has been low because endowments and government support has been huge. This is all fading though, and costs are still climbing. Look out above.
  • Finally, in “Other”. We have cosmetics, perfume, bath, nail preparations (yes that’s a category) +2.3% m/m. Financial Services ex-Inflation Guy +0.87% m/m. Haircuts and other personal care services +0.66%. Notice something there? A lot of wages.
  • On the plus side, “Funeral expenses” was -0.5% m/m. So we got that going for us. Cigarettes +1.1% m/m.
  • While I wait for the diffusion stuff to calculate I’ll start the (brief) summary call. Dial the conference line at <<redacted>>. I’ll start in 3-4 minutes.
  • OK last chart. The red line here isn’t really going off the chart (yet) – it’s median at 6.99% (est). The EI Inflation Diffusion Index – no surprise – is not coming off the boil. Inflation remains high, but also broad. Some categories are slowing, but some are accelerating!

Honestly, I came into today thinking that this was a less-important CPI report than we had seen in a while. As I said in the walk-up, I thought the real question is whether this changes the Fed’s decision at the next meeting, not this month’s meeting. As it turns out, the answer to that is probably yes (but we have another CPI before that meeting). But the more important question that has re-surfaced is, “have we really seen the highs in inflation yet?”

That seems crazy to ask, if you believed that this was all one-offs caused by clogged ports and “supply constraints.” It hasn’t been about that in a long time – and really, never was, since those clogged ports were caused by artificially-induced demand – but if you’re still in that camp you’re utterly shocked here. But it still seems wild to ask from my perspective. My view has been that if the money supply has risen 42% since the beginning of the COVID crisis, and prices are only up 15%, then prices have a lot more to do before they are in line with money growth. But I thought that would happen more gradually, with a 5%ish inflation that stuck around longer than people expected.

That’s less clear now. If core services ex-shelter is really taking the baton from core goods, that’s really bad news. Because core services ex-shelter is where wage pressure really lives. We don’t import services; we pay people to provide them. If you want a wage-price spiral, look in core services ex-shelter to see if it’s happening. Honestly? That part of CPI was already looking a little spritely in recent reports. But it looks to have really broken out now. That’s very disturbing. It adds momentum to the CPI.

Ultimately, it’s still all about whether there’s too much money chasing too few goods. But if a wage-price spiral gets started, then that will manifest in higher money velocity over time so that even slower money growth will be associated with rising prices. That’s a bad thing.

By the way, it isn’t anything the Fed can break with interest rates. Decreasing the money supply has never really been the Fed’s focus, but that’s the lever they needed to be moving. And now? Doing that now would have less of an effect, if we have momentum in pricing again.

It’s still the right move, but the FOMC has made a terrible mess of this and is going to wear it.

That being said, there is another CPI due before the next Fed meeting. My thinking had been that the Fed figured they were close to done (otherwise, Powell beating his chest with the manly-but-vacuous ‘until the job is done’ thing…which by the way is going to become a meme just like ‘transitory’…just didn’t make any sense), so that if this number was as-expected they would be considering just how soon to pause their hikes. Maybe as soon as November. Now, that’s sort of out the window.

The market reaction makes eminent sense given this backdrop. But you didn’t need me to tell you that. Before this even printed, the fact that expected real equity returns were basically below long-term TIPS returns meant that being in equities didn’t make a lot of sense. It makes less now…at least, at this level. We may be about to see a different level.

High Prices Don’t Cure High Prices

April 23, 2022 10 comments

This was an interesting week, in which it seemed that equity investors finally and abruptly got the message that high inflation is bad for the market; increasing interest rates are bad for the market; declining bid/offer liquidity is bad for the market; high energy prices are bad for the market; global geopolitical unrest is bad for the market; and a strong dollar is (eventually) bad for the market. The last two days in the stock market was a remarkably steady and orderly melting. Will it continue? Well, none of those trends I just mentioned look as if they are about to change significantly, so the only question is whether the extraordinary popular delusion returns.

The proximate cause for the selloff seems to have been the hawkish talk from Fed speakers, including the floating of the trial balloon early in the week about the possibility of a 75bp tightening. By the end of Friday, Cleveland Fed President Mester was actively pouring cold water on the notion that anything so aggressive was out of the question, while still talking in terms of 50bps increments.

I admit that as of only a few months ago, I didn’t think the Fed would hike rates more than about 75bps in total before they lost their nerve. On the other hand, they’re about 500bps behind the curve, so color me surprised…but not impressed.

To be sure, I also thought the stock market would have reacted before this point. And I do think that it is easier to talk about how much you’re going to work out this summer until it gets hot. So we will see.

But, on to my real topic today: the annoying canard that “high prices are the cure for high prices,” which is a phrase so absurd on its face that the discussion really shouldn’t go much further than that. The phrase implies that we can’t have inflation because if we have inflation, then prices will come down. It’s one reason that people are expecting used car prices to drop by as much as they previously rose – because “no one can afford a car at those prices!”

The idea is that as prices rise, the amount of money in your pocket can’t buy as many things. Therefore, real demand must suffer because higher prices mean that people can buy less stuff. Ergo, inflation causes recessions (which is weird, because we are always told how expansions cause inflation – which means that expansions must cause recessions. Are you feeling a ‘down the rabbit hole’ sensation yet?).

This is another example of a stock-flow fallacy. Or maybe it’s a fallacy of composition. It’s a micro/macro mistake. The point is that it doesn’t work that way.

The system can’t run out of money. If prices go up 25%, it doesn’t mean that you can buy 20% less stuff. Well, perhaps you can buy 20% less stuff, today, until you run out of money. But the person who sold you the car now has 25% more money than he would have previously, had he sold the same car before. Maybe you are out of money, but he has 25% more money. The money doesn’t leave the system when you buy something. It only leaves your wallet. (The stock market works exactly the same way, and no one ever questions why stock prices can’t keep going up because investors are using up all of their money, right?).

Now, if the total amount of money in the system is the same today as it was before the 25% increase in prices, and the velocity of exchange doesn’t change, then yes – that 25% price increase won’t stick because in aggregate we will be spending the same amount of money at higher prices, which means we take home fewer goods and services. If on the other hand the amount of money in the system went up by 25%, then total expenditures (if velocity is roughly constant) will be the same in unit terms as before. The system doesn’t grind to a halt and force prices lower. The system reaches equilibrium at prices that are 25% higher. By the same token, if there is 40% more money in the system, then those 25% price increases won’t be enough, there will be shortages, and prices will keep rising.

This seems like a good point to recall that M2 money since the end of 2019 has risen 42%. Tell me again why Used Car prices need to retrace so much?

The real question, to me, is why more prices haven’t gone up 42%. My answer is that we are still in the adjustment period. It takes time for that money to wash around the system, and it’s still on the rinse cycle.

Summary of My Post-CPI Tweets (March 2022)

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy. Or, sign up for email updates to my occasional articles here. Investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Get the Inflation Guy app in your app store! Check out the Inflation Guy podcast!

  • It’s #CPI #inflation day again, and a watershed one at that. If you had told me back at the beginning of my career in 1990 that we would see 8.5% inflation again, I would not have been surprised. If you had told me it would take 32 years, I would have been flabbergasted.
  • But, here we are. The consensus Bloomberg estimate is for 8.4% on headline inflation with 6.6% on core. That’s monthly of about 1.25% and 0.5% (!) But last month, the interbank market was looking at an 8.6% peak, so I guess that’s good. Energy has come off the boil some.
  • But this is the first number that is fully post-Ukraine-invasion so it will still get a big dollop of energy inflation.
  • Before I go on: after my comments on the number, I will post a summary at https://mikeashton.wordpress.com and later it will be podcasted at http://inflationguy.podbean.com . And all of that also will be linked on the Inflation Guy mobile app. Please stop by/tune in.
  • First, the good news. I expect today’s figures will mark the highs for the year. The comps get really hard hereafter: in April 2021, Core CPI rose 0.86% m/m, 0.75% in May, and 0.80% in June.
  • The bad news is that inflation might not ebb very far. The last 5 monthly core prints have been between 0.5% and 0.6%. The central tendency of the distribution appears to have moved up from 2-3% to maybe as high as 6%+.
  • That means that even when inflation is at an ebb, we’re looking at 3-4 ish, not 1ish. More good news though! The Fed in theory has total control of this. If it aggressively shrinks the balance sheet, then it can wring inflation out of the system.
  • I have no doubts that the Fed has the tools. There have been signs they aren’t focusing on the right ones. And there’s at least new vigor in the talk. But I am still skeptical that they are willing to break things.
  • By aggressively shrinking the balance sheet, I don’t mean $60bln a month; I mean taking the whole thing down to $2-4T in a reasonably short period of time.
  • But while it now looks like the FOMC will bull ahead with 50bps this month (surprising me), I just can’t bring myself to believe that it will crack the stock market and keep tightening through the recession we’ll get in late 2022/early 2023.
  • 275bps of rate hikes? Color me skeptical as soon as the growth data starts to flag a bit, or unemployment ticks up.
  • That’s really the longer-term question. Will the Fed do what it takes to break the cycle they put into motion, by reversing it? AND will they resist responding to the next recession with more of the same? I have my doubts. Would be happy to be wrong.
  • Wages, food, and rents have been booming. There is some feedback going on here. Of course, the main culprit continues to be the huge increase in the quantity of money over the last few years. The rest of it is micro.
  • But if you’re looking at supply chain issues – they haven’t gone away. In some cases they’re getting worse. As a reminder, though, that’s how inflation manifests, is in shortages of things that are over-demanded thanks to the money gusher. Prices adjust in response.
  • The bond market is starting to adjust to the realities of a hawkish Fed although not yet really putting rates at anything we would consider neutral (with a 10y rate around GDP+desired inflation, say 4-5% total).
  • Over the last month, inflation expectations have been broadly unchanged to slightly lower – although a lot of that is carry going away. Real rates are up 50-100bps, and nominal rates up 80-85bps. That’s big, but not nearly big enough to make a serious difference.
  • Why hasn’t the stock market begun to reflect the higher inflation? Partly because inflation expectations still haven’t firmly broken higher. And, after all, real rates are still slightly negative. But we’ll get there.
  • Now, in today’s number we will look aghast at the food category. High and persistent inflation in food and energy is not something policymakers can do a lot about, but it IS what leads to global political unrest…which leads to more supply chain problems and de-globalization.
  • Rents will remain high, currently trending towards 5-6% as Primary Rents continue to adjust post-eviction-moratorium.
  • And Owners’ Equivalent Rent remains high but steadier (at least recently). This is likely to remain so for the rest of 2022. Remember, the rent pieces are the big slow-moving pieces. Usually slow-moving, that is.
  • On the other side, I think there is a chance that Used Cars are a drag although prices themselves aren’t going to go back to the old levels. Might retrace a bit, but the new price level is higher – that’s what the money does. So rate of increase will decline. Level? Not so much.
  • But airfares and lodging away from home may be adds. Look as usual for the breadth; the odd stories will be the categories that did NOT rise.
  • I’m also still watching the Medical Care subgroup, as the inflation there has remained surprisingly tame through all of this. Only Medical Care and Education/Communication are below 2.5% y/y among the major categories! They’re due to participate eventually.
  • Here we go. Three minutes. Good luck. Take a picture to remember this by. At least until we get higher numbers in 3 years.

  • Pretty close. The headline number showed 8.5% y/y because the monthly number was just a little higher than expectations. But with all the volatility, that’s a great consensus estimate. Core was quite soft, at 0.32% m/m. Well, that’s soft these days.
  • Y/y core CPI therefore was only a snick or two higher, 6.44% y/y vs 6.42% y/y last month. As a reminder, hard comps are coming up so that probably marks the highs in both headline and core. Question is how far and how fast they drop.
  • That was the lowest core CPI figure since the three soft ones of July/Aug/Sep last year. We’ll look at the components.
  • A big culprit was, as I thought it might be, Used Cars. The private surveys had had a decent drop recently; in the CPI they were -3.8% m/m so that the y/y is “only” 35.3%.
  • Airfares, were +10.7% m/m. Lodging away from home +3.28%. But those are smaller weights. New Cars were only +0.18% m/m, so it does look like while New Car prices are going up, Used Car prices are also going down to re-establish a more normal relationship. This will take some time.
  • Car and truck rental was +11.7% m/m. That’s remarkable too. Rental car companies are having trouble getting enough new cars, and that’s one reason used car prices won’t plunge any time soon. But also, people are traveling again!
  • Food & Beverages: +0.96% m/m, +8.5% y/y. Food prices won’t recede soon. In addition to the loss of Russian and Ukraine supplies, there has been a recent culling of chickens due to bird flu. Like we needed that.
  • Core inflation ex-housing declined from 7.6% to 7.5%. Big whoop.
  • Core goods prices, thanks significantly to Used Cars, decelerated to 11.7% from 12.3%. But core good prices accelerated to 4.7% from 4.4%. Until the last 3 months core services hadn’t been at a new 30-year high, but they are now.
  • Remember, services prices are the slower-moving ones. BTW, this month Primary Rents were +0.43% (y/y up to 4.54% from 4.31%) and OER was also +0.43% (y/y 4.45% vs 4.17%). Both still headed higher but both slightly lower than last month.
  • In Medical Care: medicinal drugs was +0.23%; Doctor’s Services +0.49%; Hospital Services +0.40% for an overall increase in medical care of 0.55% m/m. Y/Y up to 2.86%.
  • Education/Communication was DOWN m/m, -0.17%. It’s really the only holdout category here. And if you want to find a place where there should be adjustments to LOWER quality post-COVID (implying more inflation), this is it!
  • Haven’t talked abt Apparel for a while. The y/y increase there is now ~6.8%. Apparel is a category that has been in deflation on net since the Berlin Wall fell. We import almost all of it. And prices have recovered the entire COVID discount and don’t look like they’re slowing.
  • Looking at housing, it is now running a bit hotter than my model; however, I think we could get an offsetting snap-back above the model reversing the underperformance during the eviction moratorium.
  • The main problem with housing inflation isn’t that it is going to 18%, but that it is slow-moving and it’s going to stay high for quite a while. High means 4.5%-5.5%, maybe a bit more even; given its weight in the CPI that means core CPI isn’t going back to 2% soon.
  • Market check, just for comic’s sake: Stocks absolutely love the decline in used cars which led to a softer core number. Breakevens are lower, but not so much.
  • While I wait for the spinning beach ball, this is a good time to remind you that a summary of all of these tweets will be on https://mikeashton.wordpress.com within an hour or so after I conclude. Then later today I will have a podcast version at https://inflationguy.podbean.com
  • The median CPI chart kinda tells the story. This was really never ‘transitory.’ The entire distribution has been steadily moving higher and breaking from the old range to a new range.
  • People ask me the best inflation hedge these days? For most normal people with normal amounts of money (annual purchases of these are limited), i-series savings bonds are the best deal the US Government offers. Maybe ever, at least when real rates everywhere else are negative. “The interest rate on inflation-adjusted U.S. savings bonds will soon approach 10%”  https://on.wsj.com/3rkEFVw
  • We put our database in the cloud so everything is super slow at the moment. I’m going to call a halt here. Some of my other regular charts will be in the post, at https://mikeashton.wordpress.com , so stop by later and check it out (or go there now and subscribe to the post).
  • Bottom line is that the basic story is the same. Broad and deep inflationary pressures. Don’t get distracted by the used cars thing; it didn’t create the inflation and it isn’t putting it out.
  • No sign yet that these pressures are ebbing. In fact, the acceleration in Medical Care bears watching. Also, the extended rise in food & energy is going to have other repercussions.
  • Is the Fed going to hike aggressively and (more importantly) squeeze down the balance sheet aggressively in this context? If stocks and bonds were going to be unchanged, sure. But they’re not going to be.
  • Treasury probably can’t sustainably manage the debt if long interest rates get to 5% (unless inflation stays at 8%). And stocks aren’t worth the same when discounted at 5% as when discounted at 1%. I am confident the Fed will blink. Maybe not as early as I originally thought.
  • One final word and chart. 75% of the weight in the CPI are now inflating faster than 4%. More than a third of the basket is inflating faster than 6%. This is an ugly chart.
  • Thanks for tuning in. Be sure to call click or visit! https://mikeashton.wordpress.com  or https://inflationguy.podbean.com  to get the podcasts. And download the Inflation Guy app!
  • Correction here…the y/y should move up to more like 4.9%, not 4.5%.
  • Highlighting that the number today was mostly dampened by used cars…looks like Median CPI will come in something around 0.5% again. Since September it has been 0.4-0.58% and the y/y will move up to around 4.5%. So don’t get too excited (equity dudes) about the softer core.

The Federal Reserve didn’t get any favors from the Bureau of Labor Statistics today. While the core CPI number was a little below expectations, that miss was entirely due to Used Cars. But while that category was an early champion of the “transitory” crowd, the fact that used car prices are declining slightly after a massive run-up is not a sign that the broader economy is slipping into deflation! It is a sign that that particular market is getting into slightly better balance.

Don’t confuse the micro and the macro. We get wrapped up in the supply and demand thought process because that’s how it works at the micro level. When we look at a product market, we don’t see ‘money’ as being a driver. It is, because you can think about the inflation of any item as (general price inflation) plus (basis: difference in the item and overall), where that basis is driven by those microeconomic supply/demand effects. The former term drives the overall level of inflation; the micro concerns drive the relative price changes. The used car market is getting into (slightly) better balance, but other markets are getting worse. Until the overall level of money growth slows a lot, and the aggregate price changes catch up with the aggregate change in the money supply, inflation is not going to vanish no matter what happens to “aggregate demand.”

As a reminder, M2 has risen some 40% since early 2020. Subtract out net real growth, and you’d expect to see 25%-30% aggregate rise in the price level – if M2 growth went flat. That’s why I say that if the Fed wants to crush inflation, it actually needs to cause M2 to decline, not just level out at 6%. I don’t see any chance of that happening because to do it the Fed would need to remove basically all of the excess reserves and make banks reserve-constrained in lending markets so that lending declines. This seems very unlikely! So will the Fed tighten 275bps? Someday…maybe over a couple of cycles when the real damage from inflation finally wakes them up. Right now, this is a short-term problem to them. I don’t think they’re willing to take a massive market correction to solve what they believe is a short-term problem.

What Happens Next?

March 29, 2022 3 comments

As far back as I can remember, I’ve been fascinated with the fetish that investors have about forecasts and predictions. When I was a strategist, clients wrangled me for a simple statement of where the market was going to go. I had my opinions, to be sure, but by the time I was a senior strategist I also knew that even good forecasters are wrong a lot. Forecasting, ironically, is not a job for people who care very much about being right. Because if they do care about being right, even good forecasters are depressed a lot.

So in my mind, a useful strategist was not one who gave all the right answers. Those don’t exist. A useful strategist was one who asked the right questions. Investing isn’t about being right; if it was, there would be no need to diversify. Just put everything in the one right investment. No, investing is about probabilities, and about maximizing the expected outcome even though that is almost never the best outcome given the particular path of events that actually transpires. Knowing the future is still the best way to make a million dollars.

A valuable strategist/forecaster, then, is not the one who can tell you what they think the actual future will be. The most valuable strategists have two strong skills. First, they excel at if-then statements. “If there is conflict in the Ukraine, then grain prices will soar.” Second, they are very good at estimating reasonable probabilities of different possibilities, so you can figure out the best average outcome of the probability-weighted if-then statements.

However, there aren’t a lot of great strategists, because those same characteristics are exactly what you need to be a good trader. I can’t remember if it was Richard Dennis or Paul Tudor Jones or some other legend who said it, but a good trader says “I don’t know what the market is going to do, but I know what I am going to do when the market does what it is going to do.”

As an investment manager/trader, that’s the way I approach investing. I don’t often engage in a post-mortem analysis about why I was wrong about how a particular chain of events played out, but I often post-mortem about whether the chain of events caused the market outcomes I expected, or not, and why.

All that being said, people keep asking me what I think happens next, so here is my guess at how the year will unfold. Feel free to disagree. I don’t really care if this is what happens, since my job is really to be prepared no matter what happens. But, you asked.

  • I suspect the conflict in Ukraine will continue for quite a while. I also think there’s a reasonable chance that other countries will take advantage of our distraction to be adventurous on other fronts. April is a key month, and I think Russia might be waiting for this other front to open up before pushing harder in Ukraine.
  • However, except inasmuch as the geopolitical uncertainty plays into the general deglobalization of trade, I don’t think about particular outcomes of Russian or Chinese adventurism. I don’t think the long-term inflation trajectory has a lot to do with who is invading who. In the short term it matters, but in the long run it means certain goods will have different relative prices compared to the market basket compared to what they have now – not that incremental inflation of those items, the rate of change of those relative prices, will continue. For example, cutting off the supply of Russian natural gas to Europe would permanently raise the relative price of nat gas in Europe, but after prices adjusted it wouldn’t permanently cause a higher level of inflation of natural gas.
  • March’s CPI print, released on April 12th, will probably be the high print for the cycle for headline inflation, at around 8.5%. Core inflation will also peak at the same time, around 6.50%. This is mainly due to tough comps, though. Monthly prints will still be running at a 4-5% rate, or higher, for at least the balance of the year, and we will end the year with core around 4.5%-5%.
  • The Fed is going to tighten again. I doubt they go 50bps at this next meeting unless the market is expressing desire for that outcome. The market sometimes fights the Fed, but the Fed these days doesn’t fight the market. The FOMC might even start reducing the mammoth balance sheet through partial runoff, but I suspect they will pocket-veto that and not do anything for a couple more months.
  • Interest rates are going to go up, further. Real interest rates are going to rise – actually, our model says that more of the rise in nominal interest rates so far should have been real rates, so TIPS are actually marginally expensive (which is very rare). Long-term inflation expectations are also going to continue to rise, until at least 3.5%…something in line with the reality of where equilibrium inflation really is now, with an option premium built in to boot.
  • Although the near-term inflation prints will come down, the increase in longer-term breakevens means that expectations of the forward price level will continue to rise. The chart below shows the level at which December 2027 CPI futures would be trading, based on the inflation curve, if some exchange actually had the courage to launch CPI futures. One year ago, the implied forward level of 310, compared to the November 2020 level of 266.229, implied that the market expected inflation from 2021-2027 to average 2.2%. That was in the thick of the “it’s transitory” baloney. Today, the theoretical futures suggest that inflation from 2021-2027 will average 3.6%, and that even ignoring the inflation we have seen so far, the price level will rise 3.25% per year above the current level over the next 5.75 years.
  • Stocks are going to decline. It is a myth, unsupported by data, that stocks do well in inflationary periods. At best, earnings of stocks may increase with inflation (and even exceed inflation in many cases since earnings are levered). But multiples always decline when real interest rates and inflation rise. Modigliani said it shouldn’t happen. But it does. And the Shiller P/E right now is around 40.
  • Then, the Fed is going to get nervous. Rising long-term inflation expectations will make the FOMC think that they should keep hiking rates, but the declining equity market will make them think that financial conditions must actually be tighter than they seem. And they’ll be afraid of causing real estate prices, which have risen spectacularly in the last couple of years, to decline as well. They will, moreover, be cognizant of the drag on growth caused by high food and energy prices, and in fact they will forecast slower growth (although it is unlikely that they will forecast the recession until it is over). And, since the Fed believes that inflation is caused by too much growth, rather than by too much money, the Committee will slow the rate hikes, pause, and possibly stop altogether. This is, of course, wrong but being wrong hasn’t stopped them so far.
  • Long rates will initially benefit from the notion that the Fed is abandoning its hawkish stance and because of ebbing growth, but then will continue higher as inflation expectations continue to rise. On the plus side, this will keep the yield curve from inverting for very long, ‘signaling a recession’, but a recession will come anyway.
  • Inflation by that point will only be down to 4-5%, but the Fed will regard what remains as ‘residual bottlenecks,’ since in their models a lack of growth puts downward pressure on inflation. They’ll stop shrinking the balance sheet, and may well start QE again if the decline in asset prices is steep enough or lasts long enough, or if real estate prices threaten to drop.

There you go – that’s my road map. I am not married to this view in any way, and am happy to discard it at any time. But I know what I am going to do when the market does what it is going to do. You should too!

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Summary of My Post-CPI Tweets (February 2022)

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy. Or, sign up for email updates to my occasional articles here. Investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Get the Inflation Guy app in your app store! Check out the Inflation Guy podcast!

  • Well, here we go! It’s #CPI Day, which this month happens to fall on the day after an intraday 60-cent drop in gasoline futures. THAT will clear your sinuses!
  • Before the walkup, let me tell ya that I will be on @TDANetwork today with Nicole Petallides @Npetallides at 11:50ET. Tune in!
  • Also, when I am done with the tweets today I will post a summary at https://mikeashton.wordpress.com . Later it will be podcasted at http://inflationguy.podbean.com. And all of that also will be linked on the Inflation Guy mobile app. Now with those preliminaries…let’s dig in.
  • We will get fresh 40-year-record highs again today, with the consensus calling for 0.8% m/m on headline (7.9% y/y) and 0.5% m/m on core (6.4% y/y).
  • The last four m/m core inflation figures have been tightly clustered from +0.523% and +0.603%, so the forecast is not terribly adventurous. There have been a few calls for hitting 8% y/y today, but I think some of those are so people can say they called for 8%.
  • We will get there next month, so no hurry.
  • That tight cluster of recent prints is really the main thrust of the story. The distribution of monthly core inflation is no longer around 0.2% per month or a little less. It’s around 0.5%. Hopefully we can get that down to 0.4% or even 0.3% eventually. But we’re not there now.
  • I should say that’s the main thrust of the CONTINUING story. This month, we have other stories courtesy of Vladimir Putin.
  • But, as a reminder, this inflation debacle started LONG before Russia invaded Ukraine. And it was committed with a worse weapon than a gun: the printing press. You can hide from a gun. You can’t hide from the printing press.
  • The Russian invasion caused disruption in the supplies of many commodities and helped spike energy prices. But remember, these are commodities. As long as Russia sells to SOMEONE, the eventual effect on energy prices will be much less than the short-term effect.
  • We covered this before with Chinese purchases of soybeans. So if Russia is constrained to only sell energy to, say, China, then China needs to buy less from, say, Saudi Arabia. Which means the Saudis have more to sell to us, or whoever previously got it from Russia.
  • Commodities are pretty similar. Part of the definition. So it disrupts the flow, but gasoline doesn’t spoil (ok, sure, it spoils, but slowly). I’m much more worried about wheat. If you don’t plant wheat this spring in the Ukraine, there will be less wheat globally for the year.
  • Now, unlike raw gasoline, which we consume in its commodity form and so shows directly in the CPI, raw food commodities don’t take the same path. Your Cheerios have oats, but they also have a lot of packaging, transportation, advertising, and so on.
  • That said, these large and sustained increases in energy affect food inflation through transportation, packaging, fertilizer too. Add to the impact of the war on planted acreage and you have the ingredients for a SUSTAINED increase in food prices for a while.
  • We usually look past food and energy, and focus on core, because food and energy mean revert pretty quickly. They won’t, this time, as quickly and that’s part of why CPI is broadening. And it’s why even after the peak, inflation won’t automatically recede on base effects.
  • Also, if energy prices spike, there is no guarantee it will affect other products so much because producers can smooth through spikes. A spike in wheat need not impact wages. But SUSTAINED increases in prices seep into those other goods and services. And they have.
  • …about wages, which is another interesting and important story. The Atlanta Fed Wage Growth Tracker, for my money the best measure of overall wage pressure since it focuses on continuously-employed people, is up at a 5.1% y/y pace.
  • Wages by that measure have actually been tracking pretty well with Median CPI. The chart of Wages minus median CPI is weirdly stable given everything that is happening. Implication?
  • What that says is that far from “not engaging a wage-price spiral,” the labor force is actually being uber-efficient at getting their wages adjusted. On average, of course, and adjusting for median not core. Median is a better sense of the middle – not driven by used cars, e.g.!
  • Does all of the transparency, the “Indeed.coms” of the world, make it easier to have a wage-price spiral because workers adjust their wage demands more quickly with better information? I wonder.
  • Back to the market and today’s figure. Here are the market changes over the last month. Yes, 1-year inflation expectations are +150bps. 10-years are +45bps. 10-year real yields are -44bps. (No surprise, with real yields down, gold is +8% over that timeframe). This is dramatic.
  • Wanna know what scares me? This chart. Money supply growth is still at 12% y/y, which is bad. But see commercial bank credit? It’s ACCELERATING. Concerning. The Fed directly controls neither of these, when they don’t control the marginal reserve dollar.
  • Now, for the CPI today. Rents will continue to boom, and used cars may settle back slightly. There are some signs of that. But that’s the fireworks. But I am gonna watch pharmaceuticals, and food & energy, more than usual.
  • The real excitement there will be NEXT month – this is Feb’s number and the Ukraine invasion hadn’t happened yet. Whatever today’s figure shows, it will just be the jumping off point for the March spike.
  • The interbank market still has the peak headline CPI in March (March 2021 was +0.31 on core, but April was +0.86, so it will be hard to have a new high in core at least after March), but now it has that peak at 8.55%. Go ahead, gasp. It’s a gasp kind of number.
  • That’s it for the walkup. Look for weakness anywhere in the number – won’t be much of it, so relish what you find. We no longer need clues about whether inflation is coming. It’s here. We need to start finding clues about a deceleration beyond base effects. Haven’t seen any yet.

  • The economists nailed this one. 0.8% on the headline, 0.51% on core (6.42% y/y on core). Yes, all 40+ -year highs. And still pretty much in the zone. Trend core inflation is right around 6-7% at the moment.
  • As expected, used cars fell a little, -0.25% m/m. But y/y still rose, to 41.2%. Other of the “COVID Categories”: airfares +5.2% m/m, lodging away from home +2.2%, new cars/trucks +0.3%, motor vehicle insurance +1.8%, Car/truck rental +3.5%. Ouch all around.
  • (of course, since they’re covid categories, lots of people will want to strip out all of that).
  • Food & Beverage major category: +1% m/m, up to 7.62% y/y. That’s the largest y/y rise in that category of CPI since 1981.
  • Core Goods at 12.3% y/y. Core Services 4.4%.
  • Rents: OER was +0.45% and Primary Rents +0.57%. Both represent accelerations over last month. Y/Y is at 4.3% for OER and 4.2% for Primary.
  • Medical Care continues to be a conundrum. Overall, that category rose 0.17% m/m after +0.85% last month. Pharma was +0.4% and continues to be the strong one. Doctors’ Services fell again. And this month Hospital Services also fell. I don’t understand that at all.
  • Core inflation ex-housing was 7.60%. in March 2020 it was 1.49% and it fell to 0.33% in May 2020.
  • Apparel, +0.72%. Recreation +0.73% m/m. “Other” +1.06% m/m.
  • Within Food & Beverages: Food at home (8.2% of the CPI): +1.4% NSA m/m; +8.6% y/y. Food away from home: +0.4% m/m, +6.8% y/y. Alcoholic Beverages +0.9% m/m, +3.5% y/y.
  • Food at home AND food away from home both at 42-year highs.
  • drilling down, the ONLY categories of food and beverages that declined in price: Fresh Fish and Seafood, -0.70% m/m in NSA terms, Bananas, -0.10%, Lettuce -0.29%, Tomatoes -1.88%, uncooked beef steaks -0.19%, and Pork Chops -0.01%. Most of that was seasonal as y/y accelerated.
  • Early guess at Median CPI is +0.54% m/m, which is down only slightly from last month’s spike. That median is now looking like core is what tells you that this isn’t just one-off categories.
  • Incidentally, my median estimate might be low…the median categories look to be the regional housing OERs, which the Cleveland Fed seasonally adjusts separately. I’m more likely to be low the way the chips fell. Either way, Median at 4.60% is really disturbing.
  • Let’s do the four pieces charts. First, Food & Energy. Unlike prior spikes, this is going to roll over more slowly. The rate of change will mean-revert. But the food part I think will remain a positive inflation contributor for much longer than normal (prices will keep rising).
  • Core goods. Nothing much to say. This is beyond automobiles. Part of this is pass-through of energy prices (via freight, packaging), so it’s a non-core effect on core. Some are bottlenecks. None look to be easing in the near-term.
  • This chart, piece 3, is interesting because about a quarter of this is doctors’ and hospital services, which have been pretty tame so far. And yet, it’s almost at 4%.
  • Finally, Rent of Shelter. Almost at 5%. So actually, the core-services piece is holding down inflation now…not shelter. Remember that shelter is the big, slow piece. Some people are calling for OER at 7%. I don’t get that from my models. But still, it’s going higher.
  • …and rents are part of the wage-price feedback loop. (Remember that the dip in 2021 was largely artificial because of the eviction moratorium, and everyone knew it, which is why it didn’t change wage demands much).
  • Almost 80% of the consumption basket is inflating faster than 4%. About a third is inflating faster than 6%.
  • At least by one set of models, the OER rise may be cresting soon. I’m a little skeptical but that’s what the model says. However, it’s not going to turn around and drop, which means core inflation will be high for a while. Not just 2022.
  • So I said to look for evidence of deceleration. There’s not much. But there’s a LITTLE. The Enduring Investments Inflation Diffusion Index declined to 35 from 41. That’s not a lot, but it’s in the right direction.
  • So wrapping up: there’s no real sign of any ebbing of inflation pressures. In fact, there are some signs that food inflation will stay elevated for longer than the normal oscillation cycle. But we are closer to the end of the spike, anyway, than to the beginning.
  • Core inflation will likely peak next month, and headline inflation in the next couple of months. That’s good. But we’re not going to go back to 2%. Right now, the monthly prints point to an underlying core rate around 6%. I suspect we will end 2022 in the 5s, or high 4s.
  • If there’s any chance to get to the 3s in 2023, it would be because the Fed starts to shrink its balance sheet with some urgency. I see zero chance of that.
  • In fact, as I’ve long said – the Fed is not going to tighten at every meeting. They’ll have excuses to skip meetings and assess.
  • For example, although Russia/Ukraine has nothing to do with monetary policy, it took 50bps off the table for this month – we will get a 25bp cosmetic hike in rates – and probably means they skip next meeting. And then once inflation peaks they’ll want to see how fast it ebbs.
  • Don’t want to overtighten, you know. The net result is that inflation is getting embedded in our psyche and it will be very long until we get 2-3% core inflation on a regular basis.
  • That’s all for today. Thanks for tuning in. Catch me on @TDANetwork at 11:50ET and look for my tweet summary at https://mikeashton.wordpress.com . Curious what tools we’re working on in inflation? Stop by http://enduringinvestments.com . Subscribe to my podcast. https://inflationguy.podbean.com Etcetera!

Core inflation for the last 5 months has been in a tight range suggesting 6%-7% is the underlying trend rate; this started long before Russia invaded Ukraine. The invasion means that food inflation will take longer to ebb than it usually does, as not only are we getting pass-through from the extended period of high energy prices (affecting freight, packaging, and fertilizer) but we’re also seeing plantings in Ukraine likely to be disrupted. But it isn’t just food and energy, but everything across the board. A plurality of the consumption basket is inflating faster than 6%!

And this is seeping into wages, and quite quickly at that. Wages are actually adjusting to the level of unemployment more quickly than history would suggest they should be. Based on where unemployment was 9 months ago, the Atlanta Fed Wage Growth Tracker should be around 3.5%. Based on where unemployment is now, it should be around 5%. It’s already there.

I showed a chart earlier illustrating that wages are not trailing inflation in the way that we normally expect that they would. Workers, possibly because there’s been so much turnover thanks to COVID and possibly because of the transparency of wages these days, are getting wage adjustments that keep them about where they historically have been with respect to inflation. That’s remarkable, but also problematic if there is anything to the “wage-price-spiral” thought process.

But at the end of the day I still don’t think the Fed is willing to move fast and break things. In the classroom, the Taylor Rule says they are dramatically behind the curve and should be hiking rates. Of course, the classroom also says that they should do that by adjusting reserves, which they no longer do, so the textbook is clearly flexible. But in the real world, Fed moves do not happen on paper and they don’t just move prices and output. They also crack over-levered entities and cause financial distress in unexpected places that leads to other bad things. The Fed has “learned” this over the years and it’s one of many reasons that I don’t think we’re going to see 200bps of tightening. And probably not 100bps of tightening, in 2022. They will be cautious, measure-twice-cut-once, speak sagely and calmly in the press conferences, and hope to God that they haven’t really messed it all up.

They have.

Anatomy of a Monetary Policy Error

Well, it isn’t as if no one warned that monetary policymakers were eventually going to get painted into a corner. Long before the Covid crisis, there were many voices warning that the Fed’s tendency to ease aggressively, but to find excuses to tighten slowly, would eventually get them into trouble. And here we are.

The Federal Reserve, prior to the Ukraine/Russia war, had started to talk hawkishly about raising interest rates; that talk, combined with 40-year highs in core inflation, persuaded Wall Street economists that the Fed would raise interest rates by more than 200bps this year.

That was never going to happen, even if Russia had not invaded Ukraine. Not since the early 1980s has there been a tightening cycle of at least 200bps over 10 months that also ended with the overnight rate above where the 10-year rate had been at the beginning of that period. So the calls for 200bps of tightening with the 10-year rate under 2% was always an incredibly aggressive call. Moreover, those cycles where it did happen occurred in an era when the Fed Chairman didn’t go in front of the cameras every meeting to explain why the Fed was ‘trying to increase unemployment’ – and, in fact, back in those days almost no one outside of the financial community paid much attention to the Fed at all. Plus financial leverage, ancient source of dramatic accidents, was much lower then. So my operating assumption has always been that the Fed would probably tighten about 3 times this year, pausing in between each hike…or maybe hiking 4 times and then easing once. Especially since the Fed no longer controls the marginal reserve dollar (there being copious excess reserves), the effect of monetary policy moves is less clear…and this also mitigates in favor of taking time to assess the effect of policy moves by watching the economy evolve. Ergo, this tightening cycle was always destined to be late and halting, and focused on interest rates rather than on money supply. Such a trajectory already qualifies as a ‘mistake’ when inflation is threatening 8%.

But now there’s even more room for error. Because the skyrocketing energy prices trigger another mistaken belief at the Fed, which enhances the desire to tighten even slower/later.

The Fed thinks that rapid energy price increases have this effect on the economy: rapid increases in energy prices tends to cause slow growth or recession as those increases consume discretionary income and leave less for non-energy purchases. And recession causes a decrease in pressure on other resources, such as labor. Which, in turn, leads to lower pressure on core inflation. Since energy prices are mean-reverting (at least, the rate of change is!), the central bank is “supposed” to ignore inflation that is caused by energy price increases, since if they tighten according to some Taylor-Rule-like dictum then they’ll tighten into a recession and increase the amplitude of the business cycle. Ergo, the Russian invasion of Ukraine means that the Fed should tighten less.

However, that’s not the way this works.

Rapid increases in energy prices do in fact tend to cause recession. But inflation is not caused by too little economic slack, and disinflation is not caused by too much slack. Inflation is caused by money growth, period, and M2 money growth is currently above 12%. It is true that an increase in energy prices would lead to a decline in non-energy discretionary spending, which would limit core inflation, if money growth was low. But if money growth is high, the increase in energy prices just rearranges the relative price changes because there is plenty of money to go around. It doesn’t change the overall impact of the rapid money growth. (Small caveat: a scary recession would increase the demand for precautionary cash balances, lowering money velocity…but people are already holding such precautionary balances so it’s hard to see how that could be a large effect from this level). Ergo, when the Fed slows down its tightening campaign because of the way they believe inflation works, and especially if they decide to not shrink the balance sheet – because “higher long-term rates would be bad in a recession” – they won’t have any real effect on growth but they’ll be accommodating a much higher level of inflation.

And just like that, you have it. The genesis of a really colossal monetary policy error. Get ready.

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